July 5, 2008: Perspective

Perspective.

It’s all a matter of perspective.

As of the end of the day Friday, the best team in baseball was the Tampa Bay Devil Rays, with a .624 winning percentage, winning 9 of their last 10 games. Last year, they weren’t that good. For the last 10 years they haven’t been that good. But now they are the best team in baseball.

At the start of the year I don’t remember anyone predicting that the Rays would be the best team in baseball. Most people were picking the Red Sox, or some other power house team. Conventional wisdom that a team with solid, experienced sluggers, and solid, experienced pitching would be the best. The Red Sox (and Angels and Cubs and White Sox) are doing well, but not as well as the Rays.

And yet here we are, with the Rays at the top of the heap.

Why?

One theory, which I think is as good as any, is that they have finally taken drugs out of baseball. We all know that steroid use is way down, but probably the bigger change is the elimination of amphetamines. “Greenies” have been used by generations of ball players to increase alertness and energy levels, which can be quite helpful when you have to play ball after a four hour cross country plane ride in the middle of the night after a long game. Amphetamines were banned by baseball in 2006, so now we have a situation where older players can’t easily use steroids to increase performance, and older players can’t use Greenies to give them a boost.

That gives a distinct advantage to younger players, who are more able to bounce back from long road trips and extra inning games, than are older players with older legs.

My perspective is that we really shouldn’t be surprised that the Rays are on the top of the heap. They are a very talented team, but so are the Sox, Cubs and so on. What sets the Rays apart is that they are a talented young team.

In hindsight, it’s quite obvious that we should have been able to predict that the Rays would be the best team at the half-way mark in the season. By looking at steroids, greenies, and the advantage of picking high in the draft for ten straight years should combine to create a great team.

But virtually none of us saw it at the start of the season.

We didn’t have that perspective.

We saw who was good last year, and assumed they would continue to be good this year.

Perspective.

Okay, okay, I know this isn’t JDH’s Baseball Blog; what does any of this have to do with the stock market?

Listening to the perspective of the talking heads on CNBC, you would think that the markets are at a temporary bump in the road, but once we get through this minor set back it will be onward and upward from here. Here’s my perspective:

The U.S. government deficit is freakin’ huge. I did some quick searching, and although there are interesting sites like the U.S. National Debt Clock, there’s not a lot of great information on the U.S. deficit. However, it appears that the budget deficit was $166 billion in May of this year. That’s the deficit for one month, not an entire year, and is a big increase from the $67 billion deficit in May, 2007. Apparently $48 billion of that was the “stimulus” checks, at $600 each, sent out to Americans. (I don’t want to slag Americans on their national holiday, and we Canadians are almost as bad, but c’mon guys: they are buying you with your own money!).

The problem will only get worse. Senator Dodd wants a $300 billion mortgage default bailout, and the war keeps going, and revenues are falling. The aging baby boomers are now the most powerful group in America; they are used to having government do everything for them, so universal health care is just around the corner. That may well be the final nail in the U.S. currency coffin. (Trust me, I know; I’m Canadian; we are used to waiting for hours in emergency; universal health care is only the answer if it’s funded by government but provided by private enterprise, but that’s another discussion for another day).

So Americans get all of this money from the government, and they spend it, which is good, because it stimulates the economy. Unfortunately, a significant portion of the goods purchased are foreign goods, which makes the U.S. trade deficit freakin’ huge. The trade deficit will be around $750 billion this year. We buy oil from the Middle East, and goods from China, and resources from everywhere else, and it’s non-Americans who are lending Americans the money to buy their goods (just like a vendor take back mortgage when you buy a house).

Connecting the dots, this means that non-Americans hold a lot of American dollars. They realize these dollars are losing value, since they aren’t backed by anything, so they gradually want to convert these dollars into something real, like buildings or businesses in America, or perhaps into gold or other commodities. Either way, that depresses the American dollar, and makes it even more difficult for Americans to continue to finance their lifestyle with other people’s money.

But wait, it gets worse.

In case you have been living in a cave for the last few years, the price of gas is going through the roof. The price at the pumps is approaching double what it was a year ago. This is due in part to the concept of Peak Oil; the discovery of new sources of oil peaked in 1960, and even though oil production continues to increase, the world is rapidly depleting it’s reserves, particularly as emerging economies like India and China switch from bicycle power to gas power. Silly government officials can blame “speculators”, but that’s silly; we are using more of a declining commodity, so obviously the price will increase.

As energy prices increase, so do the prices of everything else, because we need energy to grow and move our food and goods, so they are all increasing in price. Corn, for example, is at record highs.

Of course part of the reason corn is at record highs is because we are now burning corn for energy. Yup, that’s right, rather than using food to feed the world, we are burning it so we can drive our SUVs.

And wait, we forgot to talk about the mortgage mess. There are now more than a million U.S. homes under foreclosure. The housing decline will continue, which eliminates the ability for home owners to borrow against their home for more spending, which has been fueling growth for the last few years. There goes the economy.

Specifically, interest rates will go higher to slow the slide of the dollar, but inflation will continue to increase as the government prints more and more money. So yes, we will have inflation and a slowing economy, all at the same time. Stagflation isn’t fun, and it’s not easily solvable, since you need to “suck and blow” at the same time to cool the economy and heat up the economy. The world will continue to flee from the dollar, and as they do, gold will move much higher, because we all need to put our wealth somewhere.

To repeat: in a bad economy, stocks go down, so we won’t be putting our money in run-of-the-mill stocks. (Have you checked out General Motors lately?). Interest rates are going up, so we won’t be investing in bonds, because bonds are inversely correlated to interest rates; when rates go up, bonds go down. The housing market is crashing, so we won’t be putting our money in real estate.

That leaves gold, and other commodities like silver, uranium, and so on.

So what did I do this week?

I sold some gold shares.

In the month of June I had a good run with K.TO – Kinross Gold Corp., G.TO – Goldcorp Inc. and AEM.TO – Agnico-Eagle Mines Ltd. At the start of June I increased my holdings, so at the start of July I took profits and sold. My reasoning, quite simply, was that the relative strength was looking toppy, so I sold them. To be clear, I didn’t sell all of my holdings. I doubled my holdings in early June, and then sold those shares this week, so I still hold a core position in all of the gold stocks.

I then immediately put in buy orders at below the current market price, generally around the 50 day moving average. The gold shares have dropped this week, so so far the strategy looks good, but unless I can get back in at lower prices my strategy will backfire.

I expect volatility, so even though long term I love gold, for all of the reasons notes above, it never hurts to grab some profits when you can.

So what’s my perspective?

I believe that at this time next year we will look back and say to ourselves two things:

First, it was obvious, in an era of no steroids or greenies, that a young team with young legs would be better than an old, slow, drug free team.

Second, it was obvious that with huge deficits, high energy prices, the mortgage mess and a weak economy, and a debased dollar, gold could only go higher. We look back and say “that was obvious”, but very few of us will have loaded up on gold stocks while we had the chance.

My orders are already in, so I hope to own more over the coming weeks. That’s enough for today. The weather looks good, so I’ll be outside for the rest of the weekend, not thinking about the world’s problems.

As always, thanks for reading, and feel free to post your thoughts, whether you agree or disagree, on the Buy High Sell Higher Forum.