“There is no mystery behind the rise in oil prices.  They rose too high too fast because of booming demand for oil for petrochemical products, electric power and shipping from many emerging economies (particularly China, India and the Middle East).  Meanwhile, the supply of oil slipped in the US, Mexico, Venezuela, Nigeria, and Russia.

But now JPMorgan analysts estimate that oil will drop to $85 a barrel from 2009 to 2011.  Even Goldman Sachs analyst Arjun Murti, who recently guessed oil might reach $200, later told Barron’s that oil will likely drop to $75 or less in the long run.

The urge to blame speculators is as big a waste of time as blaming oil companies.  Americans want more oil and gas – not more hot air from politicians.”

From Scapegoating the Speculators by the CATO Institute’s Alan Reynolds.

We once had a Democrat President who understood economics and the relationship between tax rates and tax revenue.  Can you imagine the liberal loons of today using similar rhetoric?

(HT: http://www.cato-at-liberty.org/) 

The Democratic National Committee recently ran an ad blasting John McCain for saying the country is “better off” than in 2000.  Yet, arguably, except as regards the Iraq war, Mr. McCain’s statement is true.  In turn, Mr. McCain is blasting Barack Obama for suggesting that international tensions are not as bad as they’ve been made to seem.  Yet, arguably, Mr. Obama is right.

Democratic attacks on Mr. McCain and Republican attacks on Mr. Obama both seek to punish impermissibly positive thoughts.  At a time when there exists a sense of crises over the economy, fuel prices and many other issues, this reinforces the odd, two realities of life in the United States today: The way we are, and the way we think we are.  The way we are could use some work, but overall, is pretty good.  The way we think we are is terrible, horrible, awful.  Possibly worse.

The case that things are basically pretty good?  Unemployment is 5.5%, low by historical standards; income is rising slightly ahead of inflation; housing prices are down, but the typical house is still worth a third more than in 2000; 94% of Americans do not have threatened mortgages, and of those who do, most will keep their homes. 

Inflation was up in 2007, but this stands out because the 16 previous years were close to inflation-free; living standards are the highest they have ever been, including living standards for the middle class and for the poor. 

All forms of pollution other than greenhouse gases are in decline; cancer, heart disease and stroke incidence are declining; crime is in a long-term cycle of significant decline; education levels are at all-time highs.

Sure, gas prices are up, the dollar is weak and credit is tight – but these are complaints at the margin of a mainly healthy society.

From Gregg Easterbrook’s Friday editorial in the Wall Street Journal. 

The infusion of what is called “loose money” is always a stimulating consequence for the economy in the short term.  The analogy I often use is pumping oxygenated blood into your body.

The downside is the Federal Reserve’s ability to create money without limit does create malinvestment of capital.

But the growth of the money supply is, in my opinion, very healthy for the economy.

Long-term, the creation of money out of nothing always causes inflation, which is a problem, especially for those investors whose portfolios are filled with dollar-based investments.  The reason we haven’t seen major waves of inflation despite mass creation of money is because the U.S. and global economy does not have a shortage of goods and services.  This is acting like a sponge soaking up the new money.

Remember the real definition of inflation:  It’s the increase in the supply of money which causes prices to rise when not enough goods and services are available to absorb the new money. 

The difference between today and the Jimmy Carter days of the 1970s was that back then there was a major structural problem with the economy.  Simply put, there weren’t enough factories to produce enough stuff to soak up the money being created. 

If you double the money supply without doubling the amount of goods and services, prices will eventually double.

In our current go-round, the Fed has doubled the money supply but the supply of goods and services has also doubled so it’s nearly a wash.

I say “nearly” because in reality, there is actually a lot more inflation than what the government-published statistics indicate.  In the long-term, inflation is like the tide coming in pushing up the prices of assets, including stock prices.

Investors who are concerned about the money supply growth creating inflation are certainly thinking correctly but they also have to take in to account what is happening with that money. 

A question I often get is, “What, in your opinion, is the biggest threat to the global financial markets?”

The mainstream media never touches on this but I believe that financial derivatives are the biggest threat.  These highly speculative instruments, most often used by big money center banks, are what I think would most likely trigger the collapse of the world’s debt structure.

Here’s the story.

Financial derivatives are simply man-made bets consisting of two parties.  Party A enters the bet in hopes of earning massive profits but in order to create the derivative, they need a counter party to wager against them.  This is where Party B comes in.  They enter the bet looking to hedge against some form of risk.

Say you are a financial derivatives trader.  You can speculate (or hedge against) the movement of interest rates, commodity prices, exchange rates, or just about anything else you wish to gamble on.

Those who participate in this global casino are required to place only a fraction of their bet down thus enabling derivative traders to control an enormous amount of assets using a tiny amount of money.  This is where the danger comes in.

While traders can make big bucks being on the right side of the bet, there is also the risk of crushing losses.

This is what happened recently when a rogue trader for the second-largest bank in France made a bad bet totaling over $7 billion in losses, the largest in banking history. 

But despite instances like these, the monstrous growth of financial derivatives continues.

Over 20 years ago, with derivatives trading around $1 trillion on a daily basis, I upped the gold hedge position in our portfolios to offer additional safety.  That decision protected us during the huge stock market crash of 1987 brought on by derivatives.

Today, on the same daily basis, derivatives are trading at $500 trillion.  To put that number in perspective, the U.S. has an annual GDP of $14 trillion.  That means a 3 percent decline in the derivatives market would be greater than the total annual economic output of the world’s richest nation.  Scary stuff.

If the derivative dike ever breaks, a panic would sweep the financial world.  Bonds, money market accounts, bank CDs, cash, and all other dollar-based assets would plummet in value instantaneously.

History tells you that in these cases gold, common stock, and other tangible assets not linked to paper money become a source of value for investors.  Derivatives alone are reason enough to keep a small portion of your wealth in gold-related assets. 

For the remainder of your serious money, globally and geopolitically diversify it across ownership positions for maximum safety.

How large the derivative mess will grow to before the bottom falls out is anyone’s guess.

I predict we’ll continue muddling through just as we always have but just in case this house of cards one day comes crashing down, I know my investments will be safe when the dust settles. 

That’s what I call peace of mind – and real world financial safety.    

###

Read related articles on financial safety that we’ve published.

Work with us:  Manarin Investment Counsel

That’s not my rule; it’s THE rule!

As an investor, you understand that the market is like a yo-yo climbing a flight of stairs. With that, you accept the likelihood that you will lose money about 3 out of every 10 years.

Speculators think that they are so clever that they can time the market and know when to get in and out of it.

So let’s define the difference.

Investing is:

• Putting money to work that you don’t need to spend in the short term and leaving it alone without moving it around or chasing recent winners.
• Keeping your arms crossed and staying disciplined while the crowd is urging you to sell.
• Taking your profits when everybody else is eager to buy.
• Owning a diversified portfolio with exposure to assets offering real world financial safety — in other words, a place where your money is safe in any economic environment.

Speculating is:

• Betting you can outsmart and outperform the market over a long period of time.
• Basing investment decisions on forecasts, computer trading systems, or technical analysis.
• Following the alluring advice of hucksters and charlatans offering you the golden promise of prosperity . . . for a hefty fee, of course.

There is an old Wall Street adage that says, “Bulls make money, bears make money, but pigs get slaughtered.” Amazing how simple the truth can be, isn’t it? Then how come so many so-called investors (hopefully not you) continue gambling with their serious money?

Because it seems so easy. Just look at all the material you receive in your inbox about how you can get rich trading stocks in your spare time. Or last year’s winning mutual funds touted on TV and on the radio. It’s all nonsense.

For over three decades I’ve witnessed thousands of people successfully build wealth but I have to see any of it maintained when achieved through speculation. Sure, a few luckly souls manage to make it big in a short period of time but just as quickly as their wealth was created, in no time at all it is often lost.

Here’s the reality check: Nobody I know and nobody you know has built (and more importantly) maintained wealth through speculation.

I don’t have anything against speculation so long as you are doing it with your “play money” – which is the money you can afford to lose. But most of time here we are dealing with your serious money . . . the money you need for retirement . . . and that is money you CANNOT afford to lose through speculation.

Understanding the difference between investing and speculating is key to the long term outcome of your financial future. If you are an investor, I commend you for your discipline and hope you stick with the program.

If you are a speculator . . . well, good luck.

The sign in the middle of a shopping mall reads, ”Stock Market Returns With NO RISK.”  As I approached the kiosk, I knew I was looking at the latest ad for an “Equity Index Annuity” or EIA.  They’re often also referred to as a “Fixed Index Annuity.”  If you’re over 50, you’ve probably received numerous cryptic invitations to attend a “financial” seminar with a free dinner.  More than likely, you’re being solicited to buy an EIA. 

Typically, these annuities promise guarantees for your principal or even a modest return, while “allowing you to participate in the upside of the stock market.”  In other words, “you’ll receive the gain, without the pain.”  To understand this claim, which, in my view, is quite misleading, you need to know how these products work, what you actually own and exactly what “participate in the upside” really means.

From Tim Bastian’s op/ed on Forbes.com.   

All too often when listening to a group of people casually discussing the topic of taxation, I’m reminded of the old saying, “All the world’s insane but thee and me, and sometimes I’m not so sure about thee.”

That’s because those who follow a statist (big government) agenda tell me that to soak the rich, we must increase their taxes.

Now I consider myself a rather open-minded, rational guy but when I’m confronted by an ideology that differs from my own, I want to see evidence.  Show me the proof that back up your claims. 

MAJOR PROBLEM:  In the case of taxing productivity, there isn’t any proof.  I’m done extensive research and there is nothing that shows me that the benefits of increasing taxes on the wealthy outweigh the costs. 

No surprise there since in today’s world most people blindly follow a traditional socialist model:  our progressive tax system. 

200 years ago early Americans would have overthrown their government had they been forced to pay a tax on their production.  The only federal taxes forced on them were on tobacco, liquor, and imports. 

Present day Americans are simply lifetime tax servants to an ever-growing Master in Washington, D.C. and they love it. 

So here’s a modern history reality check:

• In the 1920s when President Calvin Coolidge cut taxes, the US economy grew faster than Nebraska corn.
• When JFK cut taxes in the 1960s, America went from having one car on every block to having one car in every garage. 
• Ronald Reagan’s tax cuts in the 80s helped move us from a demand-management, consumption-oriented society to one that stimulated capital savings, investment, and production.

Translation:  Tax cuts result in healthy wealth creation for all citizens. 

One of the most inspiring individuals I studied early in my career was free market thinker Ludwig von Mises.  If you have any interest in fiscal policies that big government thugs prefer you not understand, I recommend reading anything written by him. 

In his book, PLANNING FOR FREEDOM, von Mises writes:

If the present tax rates had been in effect from the beginning of [the 20th] century, many who are millionaires today would live under more modest circumstances.  But all those new branches of industry which supply the masses with articles unheard of before would operate, if at all, on a much smaller scale, and their products would be beyond the reach of the common man.

Fast forward to 2007.  Looking back on the tax cuts of 2003 we learn that even though the tax rates of higher income individuals were reduced by 50 percent, the amount of taxes collected on the wealthiest Americans has almost doubled. 

And one more thing, the budget deficit has fallen.

It’s precisely what history teaches us – cut taxes on the wealthy and revenues to the Treasury soar.  That’s good fiscal policy. 

So what does this all mean for investors?

Depends.  Most will continue their “government will save us” thinking and hope for the best.  You and me are better off taking an anti-statist, self-educated approach to managing our financial lives and informing as many people as we can along the way. 

For most people, contributing for a company 401k plan or other pre-tax retirement account should be Step 1 when planning a financial future.  Yet it’s amazing to me the number of folks who mismanage their pretax investment options and waste a wonderful opportunity to potentially add hundreds of thousands of dollars to their wealth.

So here are 10 tips on how to be a successful at 401k investing:

1.  ENROLL & PARTICIPATE.  This is probably the most important step.  If you don’t start putting a slice of your paycheck in your plan, you will never be given the benefit it offers.  Think about it.  Outside a 401k or other pre-tax equivalent, most people have to earn at least $1.25 to invest $1.00.  For each dollar you invest in your 401k, your take home pay is reduced by only $0.75 (assuming a 25% tax bracket.)

2.  BE AN OWNER, NOT A LENDER.  The mutual funds in your 401k will likely invest in ownership positions (stocks, real estate, precious metals, etc.) or lending positions (bonds, money market accounts).  Conventional wisdom says that you have a mixture of both – a strategy I find absurd.  When you invest in lending positions you are guaranteed to lose buying power.  You will either lose it very slowly through inflation or possibly overnight if the dollar ever becomes worthless.  I recommend keeping your 401k assets fully invested in ownership positions which are not tied to the value of the dollar.  The volatility you will experience in 401k investing is a small price to pay for the long-term returns and the real world financial safety. 

3.  DIVERSIFY YOUR OWNERSHIP.  A diversified ownership portfolio will allow you to own shares of large, mid, and small company stocks.  Domestic and international stocks too.  As a hedge against inflation and geopolitical risk, I’d also keep a small chunk allocated to gold-related investments.  Your 401k may not offer all these asset classes so diversify as well as you can with the asset classes your are provided.

4.  DEMAND THAT YOUR PLAN OFFER THE HIGHEST QUALITY INVESTMENT OPTIONS.  I see the investment options offered in many plans and too often I come away unimpressed.  If your plan doesn’t give you enough asset classes to create a diversified portfolio or if all the options come with high fees and mediocre returns, ask the trustees of the plan to change this.  It’s likely their assets are also in the plan so you’ll be given credit for helping their bottom line as well as your own.

5.  LIMIT YOUR INVESTMENT IN COMPANY STOCK.  With 401k investing this is an easier lesson to swallow following the days of Enron and WorldCom.  So unless you enjoy the thrill of riverboat gambling, I don’t recommend having the bulk of your money tied to the performance of any one company.

6.  NEVER BORROW AGAINST YOUR 401K.  It will defeat the benefit that your plan offers and any loan repayments must be paid back with after-tax dollars. 

7.  DON’T CASH OUT YOUR 401K IF YOU LEAVE YOUR COMPANY.  If you leave a job you will likely have a right to your 401k assets by by taking them in cash means you will be hit with a tax bill and possibly a 10 percent penalty if you are not yet age 59 1/2. 

8.  IF YOU ARE AT LEAST 59 1/2, ROLL YOUR ASSETS INTO AN IRA.  Your 401k may not offer this feature but if it does, take advantage of it while you are still working.  This way you have access to the entire world of investments and not just the options offered in your plan.

9.  REBALANCE REGULARLY.  At least once a year, take a few minutes to rebalance the assets in your plan.  Sit down and calculate the current percentages of the mutual funds you own with your 401k investing.  Some percentages may be much higher and some much lower when compared to your initial allocation.  Many plan providers now allow your rebalancing to be done automatically on an annual, semi-annual, or quarterly basis. 

10.  COMMIT TO MAXING OUT YOUR PLAN.  I know not everybody can do this but as the very least, invest the maximum amount you can possibly afford.  Then every time your pay increases, up your contribution amount until you have hit the maximum allowed.  I promise you won’t be sorry.

When asked to state the average return of the stock market, what is your answer?

10 to 12 percent?

It’s true that this falls in the range of historical, long-term average market returns but to me, average is anything but average. 

Let’s say you and are taking a three day vacation and I tell you the average temperature is going to be 70 degrees.  What would you pack to wear?  Based on the information you know, a cotton shirt and a pair of light weight fabric pants would keep you quite comfortable. 

On this trip we start off in Omaha, NE where it is 85 degrees.  Then we head south near the equator where it is 105 degrees.  After that it’s off to the southern tip of Argentina where it is 20 degrees. 

The average temperature of these three locations is 70 degrees but how would this temperature “volatility” make you feel?  My guess is pretty uncomfortable since the actual temperatures were not in line with your expectations. 

The same holds true with stock market volatility and investor expectations.  Non-savvy investors look at the historical market returns and expect to earn 10 to 12 percent most years.  Savvy investors look at the same historical data but understand that “average” does not mean “likely.”

KEY LESSON:  Short term, the stock market is going to be volatile and the returns investors earn will vary considerably.  This will cause market timers and day traders to attempt to make speculative bets and most will lose.  It will also cause the mainstream investor to get greedy or fearful then wind up chasing performance and perceived safety thus ending up with sub par performance. 

But the most successful investors will be those who remain broadly diversified across mutual funds of common stock and maintain a long-term time horizon.  To them, market volatility is a non-issue and most will view market declines as a buying opportunity. 

In the short-term, those investments will bounce around like a handful of yo-yo’s.  But long-term, those yo-yo’s are bouncing up a flight of stairs. 

SO HERE’S YOUR REALITY:  Where does your focus lie?  On the yo-yo’s or the flight of stairs.  Your answer will tell me a lot about your long-term financial success. 

When dealing with the investment markets, there are no guarantees and any investment comes with some level of risk.  The key is to manage that risk and minimize is so that the odds of building and maintaining your wealth are on your side. 

There’s your financial goal.  Mine too!