Folks – as you know, I don’t pay lip service to the markets. The Dow dropped and recovered 1,000 points over the past week; and, if you’re looking for that kind of noise, there are plenty of sites out there discussing it.
That said, let me paraphrase many investors I talked to last week: Is the world coming to an end?
No, Chicken Little. It will still be here tomorrow. And you have to invest the same way for one simple reason: If everything does go to hell in a hand basket and the US (or your home) economy – and every business in it – fails, your money is worthless anyways. That’s true whether you hold stocks, bonds, cash, real estate. Even gold.
Just ask the fine folks in Zimbabwe. Eleven million percent inflation and growing. Yep – $100 million Zimbabwean dollars invested in gold last year would be worth less than $1,000 today – and that includes gold’s 50% rise in price.
Don’t get me wrong – we face some very tough times ahead. Let me take a quote out of a post I wrote when I was talking about the recession and the US Dollar back in March:
The credit mess needs to work itself out. (Later this week, I’ll talk about how stupid and irresponsible that Bear Stearns, Merrill Lynch, and crew have been for the last ten years.) Regular Joe American who can’t pay his mortgage today ain’t gonna be able to pay his mortgage at the end of higher-price, higher-inflation 2008.
I won’t try to predict the direction of the markets over the next six months. I’ll simply say this:
- Expect high inflation for a while;
- Expect to see some severe market swings – up and down;
- Expect to see trouble in the overseas markets if we do tighten up our trade policies;
- Expect to see trouble in US markets if we don’t;
- Expect to see the US Dollar strengthen if we do tighten up our policies;
- Expect a weaker dollar if we don’t;
Are our problems “fixable”? Yes. Still, it won’t happen in a quarter or two. We went through a trade problem like this in the mid-1980s and it took three or four years of fixing before we entered the boom of the 1990s. By that logic, our next boom would start around 2011 or 2012 – and that’s only if we can solve these more severe problems in the same timeframe.
Looking Down The Road
Five years from now, things will be better. They have to be, because planning for the alternative (total collapse of everything) will virtually guarantee your financial demise.
Think about this: Two weeks ago, Lehman Brothers, Merrill Lynch, and AIG stood tall. Today, they are all but gone. Do you think Johnson & Johnson or Wal-Mart changed their strategy or outlook over the past two weeks? Do you think that people will stop buying healthcare products…from Wal-Mart (the deep discount store)…because Lehman is gone?
At the Pabrai Funds annual meeting (I’ll post about that later this week), Mohnish said:
If you depend on borrowed money, you have to worry about what world thinks of you everyday.
You need to avoid toxic businesses. I can’t value financial companies, and that has helped us avoid this entire mess in financials. Then again, the “mess” reaches far beyond financials. Companies with toxic levels of debt are in for a real treat.
Spreading Beyond the Financials
Long-time readers know that I’ve discussed Amylin Pharmaceuticals a number of times on this site. I got some anonymous hate-mail on those (presumably from some of the management I ballbusted for taking home $21 million plus in compensation while the company’s value continued to decline last year).
Over the past six years, Amylin has increased its long-term debt by about 55% each year, and the shares outstanding have nearly doubled…without a split. In the first six months of this year, Amylin’s interest expense has nearly quadrupled on a 14% increase in revenues.
Amylin has a tough road ahead of it. It owes money to banks…banks that need to charge as much interest as possible to shore up their weak and withering balance sheets. And now, Amylin is between a rock and a hard place. Amylin has to worry about what the world thinks of it.
It can’t sell stock to raise capital. Additional debt is going to cost more than it had in the past. And Amylin can’t generate enough cash to finance its own operations. Today’s buyers of Amylin are hoping for one of two things:
- a miracle drug rushes out of the pipeline, increasing revenues so dramatically that the business can begin generating cash; or,
- a miracle cure to the credit crisis, so Amylin can continue to finance its operations and get their drugs to market.
Otherwise, Amylin will get nickel-and-dimed to financial death, as will many other companies that have to worry about what the world thinks of them.
Maybe there is something to this “buy great businesses” malarkey.
To My Friend Chicken Little
The world isn’t going to end. Sure, we have a long, tough road ahead of us. But, we’ll get through, and great businesses will survive and thrive. Five years from now, we’ll look back and say, “Man – that was crazy. I’m glad that’s over.” Twenty years from now (if not sooner), Wall Street will throw us into another mess, and Chicken Little will poke his head out again.
And if some businesses have to go away, so be it. Just because the stock market falls or stays flat doesn’t mean your investments have to. Invest in businesses that don’t have to worry about what the world thinks about them. As their competitors falter due to massive debt loads, huge interest expenses, and an inability to obtain financing, your businesses will grow more valuable.
Then, you simply have to wait a while. Price follows value, but it doesn’t necessarily happen overnight.
Changes to F Wall Street
Regular visitors will likely notice the redesign here on F Wall Street. I had to make some changes to make it more “user friendly” and get some of those old posts back out here. There is a lot of information on the site, and it gets buried deeper and deeper each time I write an article.
So, here’s what’s new:
- Amazon Banner Ad: Gone. It was slowing down the site and annoying me. We’re back to the old F Wall Street – articles and comments.
- Related Posts: Now appear at the end of each post. This randomly draws four articles in the same category so you can find relevant articles to read when you’ve finished the current article.
- Social Bookmarking: You can now add posts to Digg, Delicious, or Stumble. Admittedly, I have no idea what these are; but, the designer suggested this.
- Add Your Website: If you run a website or blog, you can now add your website to the comments section and it will appear as a link under your name in the comments.
- Latest Comments: They have returned and can be found on the left of the page (under “Categories”) as well as on the home page. You can still subscribe to the comments RSS feed; but, you don’t have to.
Those are the major changes. I hope you enjoy and thanks for visiting (and coming back) to F Wall Street!
Filed under: Economics & History
Site looks great. Keep the posts coming, although I’m sure you’re busy reading 10Qs and Ks in this environment.
I have to admit, I’ve been a bit intimidated by the magnitude of the losses and bailouts, so I especially appreciated the Zimbabwe example to allay my fears.
But it can’t hurt to grow a garden with some potatoes in it, if only to improve my green thumb!
That was not a metaphor.
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Hi Joe,
As you make your site changes, please consider adding the Value Investing News VIN button to your list of social bookmarking sites. I think you will find that it is a lot more relavant and useful to your readers than those general social bookmarking links you added. The button makes it easy for your readers to bookmark/submit your stories to Value Investing News and also to rate your content.
I provide details on how to add the button at http://www.fatpitchfinanc... Feel free to contact me if you need any help.
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Joe,
This is a bit off the topic of your post:
Can you do the “quick and dirty” math for the Zimbabwe gold example. That doesn’t make sense to me. If you purchased gold and then massive inflation happend it seems that you would be at least no worse off than before.
Thanks,
Steve
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Joe, as always you have delivered an amazing resume of the magnitude of current economic turmoil. There have been stocks that have been on my radar for the past weeks due to the market.
I’m thankful for having read your deductions about Amliyn and its relation to this economic turbulence.
Joe, I’ve taken an interest in McGraw-Hill recently, Its stock has fallen to 36-37 range. I believe it is an opportunity to invest in a formidable business with many valuable franchises but two stand out for they carry strong moats for their respective industries in Financial & Book Publishing: S&P500 credit rating services(duopoly) State Sponsored Textbooks/Educational Software.
I thought I’d share this with everyone, its the least I can do to assist others in Snapping up wonderful Business and even critique my choice.
Nice new website look 
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George and Aman: I’ll pass that on to the designer. Thanks!
Steve: Though gold is typically seen as a hedge against inflation, it still trades in real currencies and doesn’t have to move with inflation — particularly if your country’s currency becomes worthless. Investing $100 million in gold in Zimbabwe Dollars (ZWD) on September 4, 2007, you would have 582 ounces of gold (@ Z$171,703/oz). With 11 million % inflation, the currency is essentially worthless — and you have to convert gold back into a currency before you can spend it.
So, you convert those 582 ounces today at Z$71,225/oz and you get Z$55 million back — roughly US $740,000, and less than 1% of what you invested. As you wait for your trade to settle to convert your currency into something more stable, the exchange rates kill you.
Trade Date: You have US $740,000
Next Day: You have US $2,462
Next Day: You have US $8.20
Next Day: You have nothing
Though gold is typically the “anti-inflation” hedge, that is only the case when you know that you could convert it at a meaningful rate — ie, your country’s currency is actually worth something. In that case, gold may be a great safe-haven if you know your country is going to pull out of an economic mess.
Then again, if you know that, why wouldn’t you invest in great businesses that will also pull out of the economic mess?
Make sense?
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I think gold hedges against currency devaluation. The politicians can print as much $notes as they want but they cannot dig more gold out of the earth. Some of the recent gold and commodity USD price increases are due to the USD devaluation.
Joe, in your example you’re assuming the price of gold doesn’t change when priced in the currency used to purchase it and you cannot convert the purchased gold into other currencies.
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To nk,
That was the case when currencies were backed by the gold standard. When that was [stupidly] ditched a few decades back, gold became nothing more than a price on a piece of paper and hyper-inflation a la Zimbabwe became possible. A country can print money with nothing backing the currency and there is no equalizer or golden rule that says $1 US dollar should equal ten or ten billion Zimbabwe dollars.
Without a gold standard (no country uses it now), gold has no mechanism to deliver value as a real currency. (I assume that’s what Joe meant with “and you have to convert gold back into a currency before you can spend it.”)
Gold does not have an inherent value so the exchange value has to be negotiated during each transaction. During times of scarcities like hyper-inflation or total currency or total economic collapse, the exchange value of gold goes down drastically and investors can lose everything.
Either way, $100 million ZWD bought you 582 ounces of gold which is worth much less than $100 million (today’s dollars) in any currency.
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“Leverage is one thing, but trying to make a living on long term investments is another. I am salivating at some valuations too (look at defense stocks), but I have to eat. Even Ben Graham took a hit in 1929.”
mpc, i agree. i guess its impossible to make a living on investments; unless i only eat every five years or more. i believe investments are for the the distant future and the day job pays for the bills. until all the compounding starts to roll in and i could quit my job. hehehe
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Joe and Steve,
I don’t think Joe’s Zimbabwe gold example makes any sense and his explanation actually proves the counterpoint.
One doesn’t pay for gold with a stable currency and then later sells it to get currency that is undergoing hyperinflation. To do so is nothing short of incredibly stupid, as his explanation shows.
Anyone who can afford to buy 582 oz of Gold can afford to take a plane or boat trip to Zurich or London or NYC or Cape Town or George Town or anywhere else that Gold is actively traded. He doesn’t have to sell it in his home currency. If our unfortunate Zimbabwe citizen held his gold for one year and then traveled to London and sold his gold for US$, he would have more money than before. Of course, he could have also sold it for Swiss Francs, Euros or whatever he wanted. The whole purpose of buying the gold in the first place was to get out of the Zimbabwe currency.
So, Joe’s explanation of why gold would be a bad investment for Mr. Zimbabwe is actually proof that it would have been a great investment for him, if only Mr. Zimbabwe had more brains than a brick.
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I think Alan’s point makes sense if you are a billionaire that can freely move to another country. For us little guys, I see how a $10k investment in gold would not be a hedge against hyper-inflation. I don’t want to/can’t move to another country.
Question for Alan – Joe said 582 ounces of gold is worth $55 million today in US dollars. a $100 million investment in gold is now worth $55 million if he travelled to london and sold for US dollars. A 45% loss. Doesn’t that prove it’s not always a good hedge if everything goes bad, even though it was converted to a non-zimbabwe currency?
I’m trying to understand. “Mr. Zimbabwe” can buy the equivalent of $100 million of US dollars, or 582 ounces of gold. He buys gold. A year later, he moves out of Zimbabwe and to the US. He converts his 582 ounces of gold into US dollars. He now has $55 million us dollars. Either way, he moved his money out of Zimbabwe and into gold, and then out of gold and into US dollars, and he has 45% less money.
Am I missing something?
As an afterthought after reading Gold Standard’s post, if gold doesn’t back the currency, then why gold? Why not rice or potatoes (like Allen said) or granite?
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Buffett on Zimbabwe and hyperinflation-
BECKY QUICK (CNBC): OK, we had a viewer write in from Zimbabwe–I believe the name’s Mfaro Hove–who writes: `What approach would you use to invest in a country where inflation is at more than 100,000 percent a year?’
WARREN BUFFETT: The only–the only defense you have in–when money is turning into confetti is basically your own talents and earning power. If you’re the best brain surgeon, if you’re the best meat cutter in town, if you’re, you know, the best professional football player, whatever it may be, if you have your own talent, whether the currency becomes, you know, totally devalued or they go–they go to sharks’ teeth or seashells for currency, you’ll command your share if you have personal talent. So the best investment you can make is always in yourself. I tell students that all the time. If they learn how to communicate better, all the–all the things they–they develop their own talents, they don’t have to worry–they don’t have to worry as much about the currency. It’s when you’re trying to store wealth that you have to worry enormously about what a currency does.
He never mentions gold.
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WBFAN that’s AMAZING, I wish my professors would have injected the priceless wisdom you’ve shared with students. It would have saved me ALOT of pain figuring out various investments (appartment buildings, stock market etc). In the end, you do need to work to improve yourself!
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TDW,
In Joe’s example, Mr. Zimbabwe converted 100 million of Zimbabwe dollars into gold. In his explanation, he reveals this would be 582 oz of gold. At the close of trading on 9/4/07 (using the date in his explanation) the London gold fix was 680.90 US dollars/ounce. 582 multiplied by 680.90 tells us that Mr. Zimbabwe gold was worth 396,284 US dollars when he sold his Zimbabwe dollars and took possession of his gold. So it is obvious we are not talking about a billionaire or probably even a millionaire in the example.
Then, Mr. Zimbabwe, again using Joe’s timing in his explanation, takes one year to convert his gold to a currency. On 9/4/08, the London gold fix at the end of trading was 795.40 US dollars. (http://66.38.218.33/chart...) So on 9/4/08 his gold is worth 462,923 US dollars.
He has profited (almost 17%) from buying gold and then selling it for a relatively stable currency one year later. The argument that he would be stuck having to use Zimbabwe dollars doesn’t wash, in my opinion. If I had $400,000 in gold I could find a way to sell it for some other currency if I wanted. Anyone with that much could also barter for a trip to a stable country or to a financial center where he could liquidate the rest. Transporting the gold would be no problem (ignoring the security concerns) because we are only talking about 18.1 kg of gold.
Mr Zimbabwe has a choice, and it is a real one: Does he sell his gold for a relatively stable currency such as the USdollar or does he sell it for a currency suffering from hyperinflation. Joe’s explanation reveals that to convert gold to a currency in hyperinflation is stupid and he could lose it all. However, to convert to another currency that is stable would be profitable and more importantly to Mr. Zimbabwe, would be SAFE. In my opinion, Joe’s example shows that gold is a good store of value if one’s home currency is undergoing hyperinflation. Just don’t be stupid and convert the gold back into a currency undergoing hyperinflation.
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Alan, I think you just proved your and Joe’s and TDW’s points. Mr. Zimbabwe has $460,000 US – not enough to charter a private jet to Zurich and live the high life. He’s going to stay in Zimbabwe and lose all of his money the next day.
I don’t think Joe was making an argument against buying gold, but an argument FOR investing in great businesses instead of panicking and running to gold. If the price of gold goes up 10% this year and inflation in the US is 6%, you’ve made just 4%. The same is true for stocks except that you can put a value on stocks/businesses whereas, like Gold Standard said, there is no “value” in gold because it is not used to back currencies so it is impossible to know whether or not you are getting a good deal at $800 an ounce. Just ask the people and funds buying it at $1,000 earlier this year.
Putting Joe’s argument aside (sorry Joe!), Buffett was asked the same question and he never mentioned gold. I think it’s for the same reasons – no “value” versus price, and Mr. Zimbabwe (or Mr. America) can’t jetset to Zurich so we’re stuck with our home countries and home currencies.
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WBfan, I will try to address each of your points.
Mr. Z wisely invested 1 year ago in gold, buying 582 oz of the stuff. Today, in US dollars, he has a profit, with a net worth in gold of $462,000 dollars. The distance between the capital of Zimbabwe and Cape Town South Africa is the same as the distance between Des Moines and Orlando. It costs about $12,000 round trip to charter a business jet between those two cities. It shouldn’t be too much different there.
He has a profit (in USdollars) of about $67,000 in one year. He spends 12 of those on a round trip charter jet to Cape Town. He now has $450,000 in US dollars in Zimbabwe. I’d be surprised if he couldn’t buy stuff with the USD— merchants would probably want them instead of the home currency and may even give him discounts for using them, since they won’t depreciate on the way to the bank.
Just to be complete, there is friction in the transactions. With this volume of a sale, the rand refinery will charge 5% commission. For the round trip buy/sell, it will cost him approximately $40,000. After all expenses, he is still ahead. The per capita income for Zimbabwe is a bit over $2000 a year, so he could live well in Zimbabwe using his USdollars for over 100 years.
If he chooses to stay in South Africa, the per capita there is a bit over $10,000/year. He could live twice as nice as the average South African for 20 years.
Why do people assume Mr. Z is not going to know to do this? He was smart enough to accumulate a very nice fortune in Zimbabwe dollars and was smart enough to convert a hyperinflated currency to gold. To assume he will reconvert his gold into Zimbabwe dollars and lose it all to hyperinflation in 3 days would indicate he suddenly became very stupid, because he wasn’t stupid one year ago. I contend you are wrong when you say he will lose it all, because the man in Joe’s example is not stupid initially and there is no reason to assume he acquires that trait in one year.
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Taxpayers are complaining about the $700 billion wallstreet bailout, which is very eyecatching. However outrageous this liability is, why haven’t taxpayers expressed the same degree of anger and outrage over this fact: The present value of our future unfunded obligations for Medicare and Social Security is approximately $100 trillion dollars or $1.3 million per family of four. This is the real financial time bomb awaiting this nation.
The other disturbing fact is that approximately 30% to 40% (and a growing percentage) of so called tax payers (filers) do not pay any federal income tax. As a mater of fact they, in many cases, receive more back than they pay in (via unearned income credit). It seems to me that the rich and upper middle class will be stuck with lion’s share of the price tag. Mike
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As an outsider looking in on these comments, it looks like there are two different discussions happening here between Alan and the others.
Alan’s points are extremely valid and spot on in the ordinary course of economics. If everything goes to hell in your home country and you are looking to make a move out of there, gold can act as a hedge and can be converted into another currency — in your new country that isn’t subject to hyperinflation. (Or, you can skip the gold and simply invest in that country’s currency.)
The point I was making in this article assumes that 300 million Americans are not going to pack up and leave the country if everything goes to hell in a hand basket. Most would stay in the US because:
- their lives and families are in the US;
- no country would accept the 300 million refugees;
- they don’t have the means to move, especially if they can’t sell their house or get any cash out of the bank (the case in a total collapse); and,
- history has proven this.
On point 4 — there have been times throughout US history when it would have been better — from a financial standpoint, at least — to live outside the US. And yet, most Americans (I’d say more than 99.5%) stayed and “dealt with it.”
So…here’s my point: If everything goes to hell in a hand basket in the US, most people would be financially destroyed regardless of whether or not they held stocks, bonds, gold, or potatos because they would not move to another country.
Some people with the means and desire to do so would move out of the US. Others — like those in Zimbabwe — will deal with it and try to make the best of it, even if that means rolling up your sleeves and getting dirty.
Is gold a safe haven against inflation? Yes — if we don’t have global hyperinflation and you are one of the few that would leave your home country. But for regular people who stay in their home country — regardless of how smart or sophisticated they are or aren’t — even gold won’t protect them in a total and complete financial meltdown.
Me? I’d stay. So, I have to focus on buying underpriced assets. Instead of gambling on the price of gold, I feel like the odds are more in my favor if I bet on the future of the US economy five- and ten-years from now.
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Cash and Gold have one thing in common. They have no value in and of themselves. They have value because poeple have faith that they will be accepted as a form of payment by other poeple. I think gold is just another form of currency. It is the only global currency to have survived for > 3000 years.
I don’t know what this means for those trying to hedge agains short term fluctuations in any specific currency; but i do understand why gold is perceived to be a safe bet when there is no faith in other currencies. If as a US citizen you have faith in the US, it’s poeple and it’s government, i see no reason why you would prefer gold over dollars.
What’s more, if i’m not mistaken, it is forbidden for US citizens to hold large ammounts of gold as a means to preserve capital. I mean the metal not some contract.
just my 2 euro cts
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With the market chaos, the only thing I can think of is “Be fearful when others are greedy and greedy when others are fearful.” – Warren Buffett. There’s a lot of great companies getting taken down with this market downturn. I keep thinking what a great time to must have been to be an investor during the 1929 crash, mid-1970s crash. Those were one in a lifetime opportunities to invest. I think this might be one of those opportune times. Good hunting!
I love the new layout too.
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