Monday, February 23, 2015

"Never accept 'conventional wisdom' when it comes to finance. If others keep failing, why do you want to follow them?” --Ziad K. Abdelnour

U.S. ASSETS OF ALL KINDS ARE DANGEROUSLY OVERVALUED (February 23, 2015): From time to time, investors around the world become irrationally obsessed with certain assets, thereby causing them to become extremely far above or far below fair value. Such a situation exists today, as rising U.S. assets especially since November 2012 have encouraged many to sell almost all other kinds of investments to own the U.S. dollar, U.S. stocks, U.S. bonds, U.S. real estate, and almost everything which is closely related to any of the above. This has caused a chain reaction whereby those who are invested in far more compelling securities become upset with their underperformance relative to a benchmark like the S&P 500 or a plain vanilla U.S. corporate bond fund, and thereby end up switching their allocation to be more heavily invested in the United States. The end result has been a bubble which like all true bubbles is barely recognized as such because it seems like logical behavior. There are even cute sayings, such as the United States being the cleanest dirty shirt in the laundry, which encourages uncertain investors to take the leap and to put more of their money into the United States than would be prudent. Most U.S. assets have experienced all-time record inflows and are trading near all-time highs, while many emerging markets, commodity-related securities, and similar unpopular assets are trading near their lowest points in six years. Naturally this encourages many others to sell whatever is close to a six-year bottom to buy something in the U.S. which is near an all-time high rather than doing as I recommend and taking precisely the opposite course of action.

Price and time can't tell you when a given trend is going to end, but fund flows and insider behavior tend to be consistently reliable indicators. There have been record inflows into nearly all open-end and exchange-traded funds of U.S. stocks and bonds since the beginning of 2013, while there have been record outflows from many emerging-market and commodity-related funds in recent months. In the long run, selling whatever is most popular and buying whatever is least favored has been a strategy which has made fortunes for many of history's most consistently wealthiest investors. Chasing after recent performance has never yielded a single billionaire or anyone who is remotely close to that status. Therefore, it is especially timely to consider making a gradual asset reallocation away from the S&P 500, the Nasdaq, the U.S. dollar, and U.S. bond funds in order to purchase emerging-market assets especially in countries south of the equator where valuations have generally been near generational lows relative to corporate profits. This includes Brazil (EWZ and BRF), Colombia (GXG), Nigeria (NGE), Australia (EWA and KROO), Peru (EPU), and similarly disliked funds. It also includes funds of commodity producers such as junior gold mining shares (GDXJ), coal mining (URA), copper mining (COPX), rare-earth extraction (REMX), uranium mining (URA), platinum producers (PLTM), and almost all other funds related to energy, mining, agriculture, and similar securities.

If you own shares or funds of depressed assets and you are a U.S. resident, you can take advantage of their currently depressed prices if you own such assets in your 401(k), 403(b), SEP-IRA, Keogh, traditional IRA, or other non-Roth retirement account. You can convert these shares from your account to a Roth IRA and pay taxes based upon their present low valuations. As these eventually rebound, all future gains will be completely tax free. In the event that these shares don't recover but end up retreating further in price, you can choose to undo your conversion, which is known as a recharacterization. You can then wait at least 30 days, or until the first day of the following calendar year--whichever is later--and then convert them again. There is no limit to how many times you can repeat this process. It's like being able to go back in time and "unbuy" something which doesn't go up in price. It's heads you win, and tails you also win. Unfortunately, I do not know of any equivalent in any other country. It's ironic that this situation exists for U.S. residents who are mostly overinvested in U.S. assets which are dramatically overvalued and are therefore inappropriate for doing such conversions.

Brad Lamensdorf has done such an excellent job detailing why U.S. equity indices have become absurdly overvalued that there is no better way to illustrate this than to present his recent essay in its entirety:


  • Overvalued Fundamentals Outline Big Picture


  • If you want to know how much the least popular assets could potentially rally, all you have to do is to compare their current valuations with their monthly highs from January 2013. While there is no guarantee that these assets will return to where they had been just over two years ago, by historic standards this would be a relatively moderate rebound from such a level of extreme unpopularity. Almost all shares of commodity producers and emerging-market equities had been far higher than their January 2013 peaks in 2012--especially in the first quarter of that year--with many of them trading at even higher levels near the end of 2010 and at various points in 2011. If an asset has lost more than half of its value and it regains only half of its loss, then you will still end up with a profit of more than 50%. The last time that many of these assets were similarly depressed six years ago, many of them ended up more than tripling. In recent months, partly from investors chasing after U.S. assets, outflows have been even greater from most funds related to emerging markets and commodity producers than they had been in late 2008 and early 2009. Insider buying for many of these subsectors has generally been more aggressive and more pervasive in recent months than it had been at almost any other time since the early part of the century when we had similarly irrational disparities especially between technology shares and "old economy" shares. The more things change, the more they remain the same: the Nasdaq is almost all the way back to five thousand again and is set for another plunge of 60% or more during the next few years.

    During the final months of 1999 and the early months of 2000, there were numerous financial analysts and advisors who said something like this: "There are some people out there who told us that the Nasdaq was overvalued when it went above four thousand, and yet it kept going up. Then they told us it was overvalued when it reached 4500, and it kept going higher. Now the Nasdaq is above five thousand, so you should completely ignore those bears who have been wrong time after time, and listen to us when we tell you that even greater Nasdaq gains lie ahead for many more years." What did the Nasdaq do after that? It plunged 78.4% from March 10, 2000 through October 10, 2002. The bears who were "always wrong" ended up being most right when almost no one believed them. Making a trading decision based upon recent behavior is almost always a serious mistake, because any asset almost always makes a final sharp surge higher before it experiences a severe bear market. Similarly, almost any asset which is about to enjoy a powerful rally almost always first slumps to a new multi-year bottom in order to discourage investors from buying it at its most compellingly undervalued levels. Don't be fooled into believing something based upon recent performance, especially whenever something is at or near an especially lopsided historic extreme. If you had arrived on planet Earth from Mars--assuming you had terrible internet reception on Mars--you'd have no difficulty in recognizing today's asset valuations as being ridiculous. Only when you have time to emotionally adjust to any irrational situation, and time to be repeatedly brainwashed by almost everyone around you, do you progressively perceive the most absurd situation as being normal.

    Disclosure: In August-September 2013, and throughout 2014 into early 2015, I have been aggressively buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I had been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 11, with the idea of selling it perhaps in 2017 or whenever we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, FCG, VGPMX, BGEIX, VNM, ZJG (Toronto), NGE, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position since June 2013 to approximately 4% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its recent peak value--with most of that decline occurring in 2016-2017. The Russell 2000 Index (IWM) has barely surpassed its high from the first week of March 2014, while the Russell Microcap Index (IWC) has never surpassed its zenith from March 6, 2014. Meanwhile, the S&P 500 Index set a new all-time high on numerous occasions during the same period. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Monday, February 9, 2015

    "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down." --Warren Buffett

    DEFLATION IS THE MOST POPULAR AND MOST MISGUIDED BELIEF TODAY (February 8, 2015): If you were to interview a hundred or more people about the global financial markets, they would disagree about some topics. Some believe that the price of crude oil has bottomed and will continue to rebound, while others expect it to remain low for an extended period of time. Some expect interest rates to rise while others expect rates to keep dropping. Some expect the global economy to continue to grow in the coming year, while others are concerned about a slowdown. However, almost everyone agrees that inflation is not a serious concern and that one of the safest bets you can make is to assume that inflation will stay extraordinarily low or even possibly go negative throughout the world.

    Whenever there is a nearly unanimous consensus that a particular kind of behavior will prevail in the financial markets, almost everyone will have already made portfolio allocations to match this expectation, leaving almost no one left to actually cause the anticipated event to occur. If everyone has already purchased U.S. dollars in the belief that the greenback will continue to climb against nearly all other global currencies, then who will be left to buy it? There currently exist all-time record speculative positions on a higher U.S. dollar, along with similar records or near-record bets on lower currencies in almost all other countries. Almost no one is taking steps to hedge their portfolios in the event of rising inflationary expectations. The surprise for which almost no one is prepared is the one which is most likely to actually happen.

    As a result of the nearly universal belief in deflation, investors have crowded into assets which will benefit from continued declines for commodities. The shares of most commodity producers recently set or approached six-year bottoms, as have the shares of many emerging markets which are connected directly or indirectly with commodity production. The outperformance of U.S. stocks, bonds, and the U.S. dollar has created its own dangerously exaggerated situation, by convincing most investors that this outperformance will continue indefinitely. You often hear nonsensical comments such as the United States being the cleanest dirty shirt, and other theories which attempt in hindsight to explain what has already happened as logically as possible. In reality, if you had arrived on Earth from the planet Mars, you would immediately recognize that it makes no sense for average U.S. price-earnings ratios to be above 18 while Russian companies have an average P/E of only 4. Companies in nearly identical industries, such as Ecopetrol (EC) versus Exxon-Mobil (XOM), demonstrate an irrational overvaluation for the U.S. counterparts as compared with those in almost any other part of the world.

    It is particularly ironic that seven years ago--and again four year ago--investors assumed the exact opposite: that growth outside the United States would perpetually outperform growth within the U.S., and that commodities would continue to climb in price because of an irreversible increase in demand from two billion people who had moved into the middle class. These people wanted to drive automobiles, and to have real copper pipes in their houses, and to eat the same food as those in developed countries. Since 2008 or 2011, there hasn't been any change in the fundamental situation; those in emerging markets haven't decided that they prefer poverty or wish to give up their recent prosperity. However, a new myth has been created in which the U.S. economy will allegedly continue to outperform the rest of the world for many more years, which is just as illogical as the opposite myth which had existed previously.

    Nearly all funds of commodity producers and emerging-market equities have begun to rebound from six-year lows, while a few including Brazil (EWZ) and Nigeria (NGE) have lagged in their recoveries. In general, the best investment strategy will continue to be to purchase whatever is least popular at any given time and is assumed to be the most "hopeless" in being able to enjoy a rebound. The most severe bear markets are almost always followed by the strongest recoveries, and yet most investors incorrectly perceive that any uptrends following major downtrends will be muted or insignificant. The most difficult perception problem for most investors in early 2009 was in realizing that the huge collapse for global equities ensured an equally outsized and dramatic regaining of those losses, because emotionally a big drop creates the illusion that there is some kind of inherent inferiority which can't be easily overcome. We have already experienced three energetic rallies for commodity producers and emerging-market equities since 2000, but investors mistakenly believe once again that the chance of a fourth such rally is highly unlikely.

    Summary: Everyone is convinced that deflation will rule worldwide and that U.S. assets will outperform those in the rest of the world, because they're looking back at the recent past and wrongly extrapolating it into the indefinite future. Take the opposite point of view and you will prosper greatly in 2015-2016.

    Disclosure: In August-September 2013, and throughout 2014 into early 2015, I have been aggressively buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I had been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it perhaps in 2017 or whenever we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, FCG, VGPMX, BGEIX, VNM, ZJG (Toronto), NGE, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position since June 2013 to approximately 4%-5% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its December 29, 2014 peak value--with most of that decline occurring in 2016-2017. The Russell 2000 Index (IWM) barely achieved a new all-time top on July 1, 2014 and again on December 31, 2014, but these were both less than 1% above its March 6, 2014 high. The Russell Microcap Index (IWC) has never surpassed its zenith from March 6, 2014. Meanwhile, the S&P 500 Index set a new all-time high on numerous occasions during the same ten-month period. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Thursday, January 8, 2015

    "Be a contrarian. Buy when others are smiling at you. Keep purchasing as they snicker at you. As they start laughing at you, become fully invested. It might not be apparent to the financial markets now, but in all probability, gold is in the initial stages of a major bull cycle." --Irwin T. Yamamoto

    IN 2015, THE LAST SHALL BE FIRST AND THE FIRST SHALL BE LAST (January 8, 2015): What do most investors expect in 2015? If you look at the comments of most advisors and analysts, or you speak with your friends and neighbors, you will soon realize the following: consciously or subconsciously, people expect the behavior in the financial markets in the final months of 2014 to prevail throughout 2015. This isn't because of any kind of scientific method or algorithmic extrapolation, but because it's human nature to almost always project the recent past into the indefinite future. Therefore, nearly all investors anticipate worsening deflation; a continued rise in the U.S. dollar; new all-time highs for most bond funds; additional significant gains for the S&P 500 Index; large-cap U.S. equities outperforming their small-cap counterparts; additional meaningful declines for commodities and the shares of their producers; further losses for most emerging-market shares; and for central bankers around the world to continue to try to increase inflation at almost any cost.

    Before the end of 2015, it will become apparent that the above expectations are all badly off course. Already, all of the assets described in the previous paragraph have achieved multi-year, multi-decade, or all-time extremes, although investors don't appreciate how lopsided these valuations have become because everything which exists at any given time is believed to be reasonably priced. When the Nasdaq was above five thousand in early 2000 it was assumed that it would remain elevated indefinitely, and now that the Nasdaq is not far below five thousand today most investors assume that it will soon reach a new all-time zenith. However, the Nasdaq, the S&P 500, and all other U.S. equity indices and funds have become dangerously overvalued. Before they more than tripled, U.S. equities were a compelling bargain; now that their prices have surged far more rapidly than the profits of their underlying companies, the U.S. stock market is more vulnerable to a multi-year bear market than at any time in its past history. This is evident from fund flow data for U.S. equity funds, which mostly approached or set new records for total investor inflows during the past two years. The all-time record monthly inflow was in February 2000, just before a severe bear market, while the all-time record monthly outflow was in February 2009, just before one of the strongest bull markets in history. If most investors are piling into or out of anything, then the market is set to punish them rather than to reward them.

    There is an unusually sharp dichotomy between two sets of assets worldwide today: those which are close to all-time peaks, and those which are trading near six-year bottoms. While the latter don't receive nearly as much media attention as the former, most shares of commodity producers and many emerging-market equities have traded sometime since early November 2014 at or near their lowest levels since the final months of 2008 or the early months of 2009. In most cases, emerging-market bourses have enjoyed roughly similar overall GDP growth as compared with the United States, but instead of more than tripling in value as U.S. equity funds have done since early 2009, they have barely moved higher during the past six years. This has resulted in an irrational situation where a company like Ecopetrol (EC) in Colombia, merely because it is in Colombia, with more consistent profit growth, lower debt, and stronger earnings than Exxon Mobil (XOM), has moved net sideways. This is true for entire stock markets including Russia (RSX), Brazil (EWZ), Nigeria (NGE), Portugal (PGAL), Norway (NORW), and most others in South America, Africa, and much of Europe. Asian and Australian shares are somewhere in between. You'll almost never hear a media recommendation to purchase equities in Colombia or Norway or Nigeria, but that is where some of the best global bargains currently reside.

    With the U.S. dollar index reaching its highest point since November 2005, investors assume that it will continue to rally. However, we currently have an all-time record number of speculators betting on a continued climb for the greenback. Any time that a given trade becomes its most overcrowded in several decades, it becomes especially dangerous to assume that it will continue. The relevant question to ask is this: why is the U.S. dollar so strong? A response is usually in the form of some nonsense such as the U.S. being the least dirty shirt in the laundry, but in reality there is no logical reason for the greenback to be so powerful unless a worldwide recession is imminent. The same is true with commodities which are mostly trading at their lowest prices since the early months of 2009, as well as many global currencies which are doing likewise. If we are about to experience a deflationary depression which begins during the next few months, then this behavior is sensible. Otherwise, it is a glaring mispricing combination which will be followed by huge gains for commodity producers and emerging-market equities in particular, along with moderate losses for both U.S. stocks and bonds.

    It is rare to find an analyst or advisor who expects declines for both U.S. equity funds and U.S. bond funds during 2015. As unlikely as this may seem, it is the most probable outcome for the calendar year. Bonds have surged not because they represent any kind of fundamentally worthwhile investment choice, but because investors unhappy with yields of less than one percent in bank accounts have chased after yield without regard for risk. U.S. stocks have rallied because they continue to move higher, so those who are invested almost anywhere else in the world and have been disappointed with apparent "losers" have decided to eventually give in and to switch to the "winning" team. The more eagerly investors dump the most undervalued stocks to chase after the most overvalued ones, the greater the disparity has become between these groups. Finally, just in the past several weeks, the weakest names have been among the biggest winners, while the most popular indices including the S&P 500 have begun showing signs of early weakness. There continue to be sharp up days for U.S. equity indices, just as there had been throughout 2007 and during the first eight months of 2008, to discourage investors from selling U.S. stocks anywhere near the top. By the time investors realize that they should have sold, they will likely already have lost half or more of their money, just as had occurred during the 2007-2009 bear market.

    As for U.S. bonds, they seem to be in an unending uptrend. Anything which appears to be unstoppable eventually stops, and then dramatically reverses as the psychology becomes transformed from "bonds are just as safe as a bank account and will give me more income" to "get me out of these bonds at any price, because they've lost so much and I can't afford to keep losing more while I'm waiting for a rebound." This is of course exactly what happened with U.S. corporate bonds in 2007-2008, and the next year or two will be similar. U.S. Treasuries are in a different category from corporate bonds, but TLT recently surged to a new all-time high and Treasuries have become far too popular. With all-time record inflows into many U.S. Treasury funds in recent weeks, expect them to disappoint investors from now through early 2016 when they may once again become sufficiently cheap to justify purchasing.

    If you look at charts of GDX, SIL, GLDX, or SILJ, they have this feature in common: they all bottomed on November 5, 2014. Many other funds of commodity producers and emerging-market equities completed their lowest points in the morning of December 16, 2014. Some of these shares slumped to new six-year lows in January 2015, thereby providing additional good buying opportunities. Whenever it appears that bargains will last forever, they soon rapidly disappear.

    Summary: Investors are expecting additional 2015 gains for both U.S. stocks and bonds, as well as a continued rise in the U.S. dollar. All of the above will end up behaving exactly the opposite. The least-loved securities in the world, consisting primarily of the shares of commodity producers and emerging-market equities which are mostly near their lowest points in six years, will likely be among the biggest percentage winners throughout 2015 and into the early months of 2016.

    Disclosure: In August-September 2013, and throughout 2014 into early 2015, I have been aggressively buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I had been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it perhaps in 2017 or whenever we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, FCG, VGPMX, BGEIX, VNM, ZJG (Toronto), NGE, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately 5% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its December 29, 2014 peak value--with most of that decline occurring in 2016-2017. The Russell 2000 Index (IWM) barely achieved a new all-time top on July 1, 2014 and again on December 31, 2014, but these were both less than 1% above its March 6, 2014 high. The Russell Microcap Index (IWC) has never surpassed its zenith from March 6, 2014. Meanwhile, the S&P 500 Index set a new all-time high on numerous occasions during the same ten-month period. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Monday, December 1, 2014

    "Call me dummy and write a book for me: If the stock market falls 1%+ on a FAKE tweet, what does that mean when something serious happens?" --Bette Midler

    GOLD AND SILVER MINING SHARES ARE POINTING THE WAY HIGHER FOR OTHER COMMODITY PRODUCERS AND EMERGING MARKETS (December 1, 2014): Yes, you heard that right. In spite of, or really because of all the negative media hype about gold and silver, you would think that the sky had fallen and was about to crash on the heads of everyone who invests in commodities directly or indirectly. In my previous post from Halloween, I recommended that readers purchase the shares of gold and silver mining companies and their funds including GDXJ, GDX, SIL, GLDX, and SILJ. As it turned out, all of these bottomed nearly simultaneously on November 5, 2014, and have since formed bullish patterns of higher lows. On November 28, 2014, and again in the morning of December 1, 2014, gold and silver mining shares slumped but didn't nearly approach their nadirs from a few weeks earlier. This was true even though the price of silver itself, as measured by the December 2014 futures contract, plummeted to 14.100 U.S. dollars per troy ounce on Sunday evening, November 30, 2014. The primary impact of this collapse was to cause the sell stops of long silver positions to be triggered, thereby proving once again that those who use stops will succeed only in getting stopped out just before any major move occurs in the opposite direction.

    What should you do if a fund of junior gold mining shares like GDXJ had bottomed at 22.34 and is now moderately higher? Of course you could decide to buy it even though it has recently climbed sharply, but a much better idea is to observe the historic pattern in which gold and silver mining shares tend to rally from multi-year lows prior to similar rallies for other commodity producers and emerging-market equities. Funds including FCG (natural gas producers), COPX (copper mining shares), and GXG (Colombian equities), among dozens of others, slumped to five- and six-year bottoms on December 1, 2014. Knowing that precious metals producers are a leading indicator, it is thereby safe to purchase all related assets which are directly or indirectly connected with commodity production. In this way, you are continually accumulating the best bargains which are available and which no one wants to buy until they have rebounded, instead of chasing after the hottest securities which have already been progressively recovering. Eventually, the lagging assets you purchase will enjoy similar rallies.

    What reason is there for commodities to rally, given the OPEC meeting and the Switzerland gold referendum? The answer is that meetings and referendums don't determine the future prices of assets, which fluctuate almost entirely based upon economic considerations. Whenever there is a political motivation for buying or selling, such as a street protest or a change in government--or in the case of Brazil, the lack of a change in government--it is almost always profitable to trade in the opposite direction of the media consensus. If you hear even on non-financial cable TV stations why the price of oil will drop because of the OPEC meeting, or why the price of gold will slump because of a Sunday morning vote in Switzerland, then you can rest assured that the behavior of the U.S. dollar and the global economy is ten thousand times more important. The value of the greenback vs. the aussie or loonie isn't going to make headline news, because it's not very exciting and it's challenging for a journalist to create an entertaining and simplistic story line to attract viewers. However, these "boring" facts will be the key elements in determining whether the shares of commodity producers and emerging-market equities will rise or fall during the upcoming year.

    If there was anyone who was long crude oil, gold, silver, the shares of commodity producers, Brazilian or Russian equities, or the Australian and Canadian dollars, and emotionally wanted to sell out of disappointment, then the OPEC meeting and the Swiss gold referendum--along with the most recent Fed meeting, the U.S. Congressional elections, and a dozen other newsworthy events, not to mention the handy excuse of tax-loss selling at this time of year--gave these folks plenty of excuses to finally log into their accounts and close out their positions. The remaining owners of these assets are primarily highly committed, knowledgeable, value investors who will not easily be dissuaded into selling by media hype or anything else, thereby setting the stage for a dramatic extended rally. A fund like FCG, if it merely touches its June 23, 2014 intraday high of 24.12, will have more than doubled from today's intraday low of 11.89. Many funds of commodity producers will triple or more if they revisit their respective peaks from past years including 2013, 2012, and especially 2011. While nearly all analysts are concerned about how much lower these assets will go, a far more interesting and pertinent question is how high they can climb after they have reversed direction. At the end of any bear market, nearly all investors become irrationally obsessed with the potential for additional losses and forget that if something has lost 5/6 of its value then it will triple in price if it regains half of its previous top.

    Pay attention to fund flows which are ignored by almost all investors. At the same time that there have been record inflows into many U.S. equity funds in recent months, there have been all-time outflows from most assets connected with commodity production and emerging markets. Mining and energy shares in particular have suffered dramatic declines, with the percentage of the S&P 500's total market capitalization devoted to energy close to an all-time low. Relative to almost all other equity groups, the total market capitalization of mining shares is at a multi-decade bottom. In recent months, insiders have been substantial buyers of the shares of commodity producers, while the traders' commitments are near multi-decade bullish extremes of commercial (insider) accumulation. Regarding currencies, commodity pools and other speculative entities have been making all-time record bets on a rising greenback. The media are clearly on the side of these speculators, believing almost unanimously that the U.S. dollar will continue to rise indefinitely along with U.S. equities, U.S. corporate bonds, U.S. real estate and just about everything else connected with the United States.

    If the overnight action in gold and silver proved anything, as did similar behavior on November 5, 2014, it is that whenever there is a unanimous consensus that anything will happen in the financial markets then it inevitably proves to be the opposite of what actually occurs. If everyone is convinced that gold will plummet to one thousand dollars per troy ounce, then it will instead surge higher. If everyone is certain that the U.S. dollar is the cleanest dirty shirt in the laundry and will continue to climb versus all other currencies, then the greenback is likely instead to decline roughly through the end of 2015--and perhaps beyond if investors aren't sufficiently bearish toward the U.S. dollar a year from now. If everyone knows that U.S. equities are safer and more reliable than stocks anywhere else in the world, then U.S. equities will suffer a period of prolonged underperformance and almost certainly will decline by more than half as they have done in past decades whenever they have been this dramatically overvalued. It's worth noting that investors made their heaviest outflows from funds connected with the S&P 500 and other U.S. benchmark indices when the S&P was close to its March 6, 2009 nadir of 666.79, and now that it has more than tripled we have enjoyed huge inflows into the same funds. Investors love to buy high and to sell low, because that enables them to do exactly what the media are brainwashing them to do.

    Summary: Today's rally for gold and silver mining shares is pointing the way higher for the shares of other commodity producers and emerging-market equities which have continued to retreat toward five- and six-year bottoms. Buy them before everyone else realizes what is going to happen in 2015.

    Disclosure: In August-September 2013, and again throughout 2014, I have been aggressively buying the shares of emerging-market country funds whenever they appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I have been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it in 2016-2017 as we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, FCG, VGPMX, BGEIX, VNM, ZJG (Toronto), PLTM, EPU, TUR, NGE, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately 6% of my total liquid net worth in order to increase my holdings in the above assets. I have now sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its 2014 peak value--with most of that decline occurring in 2016 and perhaps continuing into 2017. The Russell 2000 Index barely achieved a new all-time top on July 1, 2014 compared with its early March 2014 highs and made a lower high on November 28, 2014, while the S&P 500 set a new all-time high on numerous occasions during the same nine-month period. The Russell Micro-cap Index has been even weaker since it completed a historic top on March 6, 2014. This marked a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Friday, October 31, 2014

    "The art of investing is not about figuring out what has already happened. It's about anticipating the future and creating the future that others will read about in The Wall Street Journal." --Joshua Rogers

    NOW THAT PRECIOUS METALS HAVE MADE A DOWNSIDE BREAKOUT, BUY THE SHARES OF THEIR PRODUCERS (October 31, 2014): If you go to any financial web site, you will find one or more articles about how gold and silver have made downside breakouts and will continue lower until they have plummeted to incredibly low prices such as one thousand U.S. dollars per troy ounce for gold or even lower targets. You'll discover plenty of analyses explaining why deflation is a serious global risk, and how the U.S. dollar will continue to climb because the U.S. has allegedly favorable interest rates and growth prospects when compared with the rest of the world. You'll see cable TV commentators telling you why the U.S. stock market will keep rallying for several more years, and why the U.S. economy will outperform nearly all other countries including emerging markets. You'll receive plenty of literature from mutual fund companies detailing why bond funds are a useful diversification for your stock funds, so you will have a pleasantly balanced portfolio of both.

    Naturally, all of the above theories are nonsense, because they assume that multi-year extremes are completely rational and will become even more extreme in upcoming years. It's certainly the case that extremes can go to greater extremes, and they often do in the short run, but eventually everything regresses toward fair value. If something is especially overvalued, it will almost always slump to an equal and nearly opposite point of undervaluation. Buying something which is close to its all-time peak is very dangerous, because you're assuming that there will be an even less knowledgeable person who will be willing to pay even more for something which is already ridiculously overpriced. You might get away with this for awhile, but eventually you'll lose money. You should instead be eager to purchase assets which are trading close to their lowest levels in several years primarily because they're unpopular and continue to receive persistently negative media coverage. A blend of stocks and bonds is not necessarily safe if both are near historic tops, since they have periodically declined in tandem in past decades.

    Many funds of commodity producers and emerging markets recently slumped to their lowest points in more than five years. If you look at charts of several of these, including EWZ, RSX, KOL, and FCG, you will see that all of the above have recovered from deep bottoms which had been achieved earlier in October 2014. They are still compelling bargains in most cases, but there is one subsector which just today slumped to a six-year nadir. These are the shares of gold and silver mining companies, along with their funds including GDXJ, GDX, SIL, GLDX, and SILJ. Obsessed with the idea of a perpetually rising U.S. dollar, pervasive worldwide deflation, and similar popular concepts which will all be proven to be transient conditions, investors have abandoned the equity group which will likely deliver the greatest percentage gains between now and late 2015 or early 2016.

    It is emotionally difficult for many investors to purchase "falling knives," because they hear, read, or see a flurry of negative commentary about such assets on a daily basis, and become subconsciously brainwashed into believing that it must be true. It was just as easy to be convinced 3-1/2 years ago that inflation would continue to accelerate worldwide, and that emerging markets would continue to outpace developed markets. The current myths will prove to be just as wrong as the opposite beliefs had been in April 2011. As any trend becomes especially extended, more and more people become convinced that it will continue indefinitely, until almost everyone is certain that something must be true just before it is dramatically proven to be false. Everyone "knew" in early 2009 that stock markets around the world would probably "never" recover, and if they did it would allegedly take many years for a moderate rebound. Today, everyone is certain that the U.S. stock market will climb for many more years, mainly because it is difficult to envision the next few years being meaningfully different from the last few years. As humans, one of the biggest mistakes we make in life, with investing and everything else, is to project the recent past into the indefinite future.

    There have never been more intense outflows from several funds of assets related to precious metals in their entire history. In December 2013, the total outflows were greater from some of these funds, but they occurred over a more extended period of trading days, and of course the bargains available at that time were also compelling. Other than that, you have to go all the way back to the summer of 1976 to find a similar period in which these were highly disliked for similar reasons: they were slumping at the same time that the overall U.S. stock market was rallying. Investors dislike owning losing assets, but they hate even more to own losing assets when other securities are approaching or setting new all-time highs. This drives an emotional desire to own the winners, no matter how dangerous they are, and to discard the losers usually just before they enjoy especially powerful rebounds.

    Gold and silver mining shares appear to be a Halloween trick. They are actually an unexpected treat--buy them.

    Disclosure: In August-September 2013, and again during the first ten months of 2014, I have been aggressively buying the shares of emerging-market country funds whenever they appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I have been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it in 2016-2017 as we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, VGPMX, BGEIX, VNM, ZJG (Toronto), PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately one twelfth of my total liquid net worth in order to increase my holdings in the above assets. I have now sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its 2014 peak value--with most of that decline occurring from some point around the middle of 2015 through late 2016 or early 2017. The Russell 2000 Index barely achieved a new all-time top on July 1, 2014 compared with its early March 2014 highs, while the S&P 500 did so numerous times over the same four-month period. The Russell Micro-cap Index has been even weaker since it completed a historic top on March 6, 2014. This marked a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Monday, October 6, 2014

    "I've found that when the market's going down and you buy funds wisely, at some point in the future you will be happy. You won't get there by reading 'Now is the time to buy.'" --Peter Lynch

    THE U.S. DOLLAR IS TODAY'S BUBBLE (October 6, 2014): During the current century, there has been an incredible procession from one bubble to the next. Everything from the Nasdaq to Canadian housing prices to small-cap U.S. equity indices achieved multi-decade peaks in both absolute and relative terms. Each time, investors have assumed that it's "the new normal" or that "we've never had this situation before, so it makes sense." The latest absurd overvaluation has occurred for the U.S. dollar, also known as the buck or greenback. Is it different this time?

    The correct answer, of course, is that it was created in the same fashion as all of the above extremes, and will be resolved with a similar slump. Especially against emerging-market currencies including the Brazilian real and the Russian ruble, the U.S. dollar has become ridiculously overpriced. The greenback has been in such a strong uptrend that most analysts are no longer debating whether it will continue, and are taking it as an "obvious" assumption that it will keep climbing indefinitely. When a consensus is building, its momentum often carries it forward. However, once such a consensus becomes nearly unanimous, as the bullish consensus is today for the U.S. dollar, then it begins a dramatic reversal which nearly always ends up with a nearly opposite extreme to the one which had previously existed.

    Thus, all of the above bubbles slumped after their creation. After reaching an all-time top in March 2000, the Nasdaq plunged 78.4% by the time it bottomed in October 2012. U.S. housing prices lost an average of 34% nationwide following their 2006 bubble top, and Canadian housing prices will likely plummet by an even greater percentage over the next three or four years. Small-cap U.S. equities plummeted in 2007-2009 and will almost surely lose as much in 2014-2017--in case you haven't noticed, they began bear markets on March 6, 2014 with IWC, a fund of U.S. companies with less than one billion dollars apiece in market capitalization, already down by a double-digit percentage. The U.S. dollar index will likely retreat to its lowest level since the fourth quarter of 2011; if this takes about a year, then this will generate a four-year bottom.

    If the U.S. dollar is on the verge of a significant decline, then numerous inversely correlating assets are set for dramatic rallies and are worth buying at currently depressed levels. Many commodities and the shares of their producers have gone strongly out of favor during the third quarter of 2014, with many emerging-market assets doing likewise. Numerous securities in these sectors have fallen so sharply that they are approaching or have already reached their lowest levels since the first several months of 2009 when they were completing their previous bear-market nadirs. The mainstream financial media coverage has been almost uniformly positive toward the U.S. dollar and persistently negative toward commodity-related assets and anything related to emerging markets.

    Historically, gold and silver mining shares are among the most reliable winners during periods of U.S. dollar weakness. With these assets having rebounded only modestly from their respective 2013 bottoms, they will likely be among the biggest winners for the remainder of 2014 and for at least part of 2015. Other mining shares, many of them near their lowest points in more than five years, will likely gain significantly in percentage terms during the upcoming year. Previously popular emerging-market equities in countries including Russia, Brazil, and most of South America have only moderately rebounded from multi-year lows reached during the first quarter of 2014, and have substantial remaining upside. While almost everyone is bailing out of these securities as quickly as possible, now is the time to gradually accumulate a variety of these assets.

    Inflation is a problem which is so certain by most investors to be "solved" that the risk of deflation is considered to be far more serious. In the past, whenever we have experienced a consensus on either side, the opposite behavior has always occurred. Thus, deflationary panic in late 2008 led to a dramatic inflationary climb by 2011; at that point, the belief that inflation would continue indefinitely led to major bear markets for the shares of commodity producers and emerging-market equities. Now we've swung all the way back again, with almost no one concerned about rising inflationary expectations. Historically, whenever U.S. equities are transitioning from a multi-year bull market to a bear market as they have been doing recently, there is a corresponding inflationary surge. Of course many people believe that "it's different this time", and of course it very rarely is different. History repeats itself with boring predictability.

    Disclosure: In August-September 2013, and again during the first several months of 2014, I had been aggressively buying the shares of emerging-market country funds whenever they appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I have been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it in 2016-2017 as we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, GDX, HDGE, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, VGPMX, BGEIX, VNM, ZJG (Toronto), PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately one tenth of my total liquid net worth in order to increase my holdings in the above assets. I have now sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its 2014 peak value--with most of that decline occurring from some point around the middle of 2015 through late 2016 or early 2017. The Russell 2000 Index barely achieved a new all-time top on July 1, 2014 compared with its early March 2014 highs, while the S&P 500 did so numerous times over the same four-month period. The Russell Micro-cap Index has been even weaker since it completed a historic top on March 6, 2014. This marked a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.

    Friday, September 19, 2014

    "Somebody said to me, 'But the Beatles were anti-materialistic.’ That’s a huge myth. John and I literally used to sit down and say, 'Now, let’s write a swimming pool.'" --Paul McCartney

    MOST GLOBAL ASSETS ARE ABSURDLY OVERVALUED, WHILE A FEW SECTORS ARE RIDICULOUSLY UNDERVALUED (September 19, 2014): We have experienced numerous bubbles throughout financial history, where various assets have become irrationally overvalued. Often this occurs because an especially popular new technology inspires investors into believing that traditional measures of valuation "no longer matter" because the new technology has "completely changed" the financial landscape. Through the centuries, this has caused investors to believe that assets including tulips, funds which invest in the New World, railroad shares, and internet stocks will keep rising indefinitely and that no price is too high. What makes the current situation particularly problematic is that bank accounts paying almost nothing around the world have encouraged millions of investors to take their money out of safe time deposits and to put them into far riskier stocks, bonds, and real estate. Most people don't even realize how much money they might lose, foolishly projecting their recent steady gains into future years. The problem with so many assets being simultaneously overpriced is that whenever the stock market suffers a significant decline, most other assets could end up declining in tandem rather than behaving inversely. Many investors have portfolio blends of 60% stocks and 40% bonds, or perhaps the reverse, and believe that if stocks retreat then bonds will advance or vice versa. However, there have been times in history when stocks, bonds, and real estate have all plummeted simultaneously. If that happens again, with so many people having crowded into these assets without understanding their risks, this creates a serious possibility of a dramatic total loss of wealth. When people's net worth slumps, even if their incomes remain constant, they tend to spend much less. This is known as the negative wealth effect, and it could be one of the most serious problems facing the economy around the world during the next bear market.

    Probably I should call it the current bear market, rather than the next one, because if you look at a chart of small-cap U.S. equities you will see that these have already been in downtrends since March 6, 2014. IWC is a fund of micro-cap U.S. equities, meaning shares of companies with a total market capitalization of less than one billion dollars apiece, which has dropped about 10% from its March 6 top. IWM, a fund which tracks the Russell 2000, hasn't lost as much but has substantially underperformed the S&P 500 Index since March 6, 2014 after having outperformed the S&P 500 for five consecutive years. The financial markets are thereby giving us a useful advance warning, which almost everyone is completely ignoring. Those who have realized that small U.S. company shares are in downtrends have mostly recommended shifting into their large-cap counterparts. This is like being on the Titanic and learning that it has struck an iceberg--and therefore recommending leaving a second-class cabin to move into a first-class cabin which has recently been vacated, rather than heading for the lifeboats. By the time that most investors realize that they should sell many of their risk assets, it will be far too late to obtain favorable prices for them. I'm sure you remember many people prior to September 2008 who insisted that they would know when we had entered a "real" bear market and would be able to get out in time--only to discover after September 2008 that they had badly misjudged the financial markets. Being proactive is almost always rewarding because so few are willing to plan in advance; almost everyone ends up trying to respond to what has recently occurred.

    Many measures of valuation have reached all-time highs, including record low yields on many classes of corporate bonds and all-time record or near-record ratios of prices to earnings and prices to book value for many equity sectors. A few measures are still below their all-time zeniths from March 2000, but are above peak valuations for nearly all other bull-market tops including 2007. Whenever too many investors are following nearly identical paths, they almost always end up losing a substantial percentage of their net worth. Many people have deluded themselves into believing that traditionally volatile assets are somehow almost as safe as a bank account, and are about to pay dearly for their willful ignorance.

    In an interesting paradox, at the same time that so many stocks, bonds, real estate, collectibles, and other assets are dangerously overvalued by historic measures, a few sectors are especially undervalued. Most emerging-market shares suffered substantial bear markets which began during or near April 2011, and which mostly ended between August 2013 and July 2014. Many of these funds lost more than half their value during this period. Investors are instinctively reluctant to purchase anything which has recently suffered a substantial percentage decline, regardless of how compelling it might be. Nearly all emerging-market funds have been rebounding in recent months, generally gaining more than U.S. equity funds, but continue to mostly be avoided.

    Many shares of commodity producers also suffered bear markets which began on or around April 2011, which slid to four- and five-year bottoms from June 2013 through the present time. The total percentage losses, as with emerging-market equities, was more than half for many commodity sectors and more than three quarters for the hardest-hit subsectors. A few of these including GDXJ have rebounded significantly from their lowest levels of the past year, while continuing to receive persistently negative media coverage and with almost all analysts and advisors recommending that their clients avoid them. There's a strange irony in advisors and analysts recommending that investors own dramatically overpriced assets which have tripled or quadrupled since early 2009, while not wanting them to buy the relatively few securities which are trading close to important 2009 lows. Emotionally, investors would almost always prefer to buy something which has been climbing for several years and which has been especially calm in recent months, because it intuitively seems to be safer and superior. Investors dislike buying something which has significantly lost value in recent years and which is experiencing sharp fluctuations in both directions, because something which behaves in this manner appears to be inferior and unpredictable. Not surprisingly, those assets which tend to rally the most are almost always those which recently suffered notable bear markets and which have gyrated choppily rather than rising smoothly in recent months. This ensures that very few people will benefit from the financial markets as nearly everyone ends up buying high and selling low.

    Disclosure: In August-September 2013, and again during the first several months of 2014, I had been aggressively buying the shares of emerging-market country funds whenever they appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I have been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it in 2016-2017 as we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, GDX, HDGE, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, VGPMX, BGEIX, VNM, ZJG (Toronto), PLTM, EPU, TUR, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately one ninth of my total liquid net worth in order to increase my holdings in the above assets. I have now sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its 2014 peak value--with most of that decline occurring from some point around the middle of 2015 through late 2016 or early 2017. The Russell 2000 Index barely achieved a new all-time top on July 1, 2014 compared with its early March 2014 highs, while the S&P 500 did so numerous times over the same four-month period. The Russell Micro-cap Index has been even weaker since it completed a historic top on March 6, 2014. This marked a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.