Are You Smart Money?

You’ve probably heard the term “smart money” used by various investing pundits. It’s a reference to those investors (often professionals) that are consistently better informed and better at making money than the uninformed masses. What makes an investor a member of the “smart money” cadre. Are you one of them?

Smart MoneyLet’s take a look at a few of the characteristics of smart money. Hopefully that will give us an idea of what makes this group of investors successful.

Smart money buys when others are fearful. A recent example of this is last year’s Gulf oil disaster. After the explosion and during the worst of the spill speculation of British Petroleum’s imminent bankruptcy caused panicked selling. The stock lost roughly half its value in less than two months. There was blood in the streets – and that was the time to buy. You’re the smart money if you bought BP after its stock price was hammered. If you had, you’d be sitting on a roughly 50 percent gain.

Smart money sells when others are greedy. In the Nasdaq Internet stock bubble of the late 1990s, many investors who had purchased Internet stocks watched their brokerage accounts swell to levels never seen before. The greed and unbridled optimism in the market was palpable. Everyone was talking about the latest internet stock sensation, the classic sign of a mania in full bloom. Many stock positions had logged spectacular gains, but the herd was convinced there was more to come. But, the smart money (I wish I could say I had been one of them) said to themselves “this can’t go on forever”. The smart money sold their Internet stocks prior to the 2000 top, just as the greed reached a pinnacle.

Smart money sees trends others don’t. A few lone voices urged investors in 1999 to buy gold. But not one was listening. No one wanted to talk about the metal or mining stocks. Gold has increased in value seven-fold (unleveraged) in the past 12 years. Enormous profits have been made in gold and gold stocks, with many stocks earning doubles on top of doubles.

Smart money ignores the headlines. This goes beyond the traditional advice of “buy the rumor/sell the fact”. Smart money largely ignores the chatter from mainstream media and instead focuses on the factors that drive headlines. When it reaches mainstream coverage, the smart money is already invested, and is looking at what will be tomorrow’s headlines.Admittedly the ability to peer into the future and divine emerging trends isn’t easy to develop or maintain. It may require years of experience to learn to sift through reams of electronic and printed information to find the nuggets. It also requires the willingness to sift through all that data. That, or you need to have the resources to pay someone else to do it for you.

Smart money doesn’t count its money before it’s made. Smart investors understand there is no sure thing – that no one is going to bail them out if their analysis is wrong. They keep a realistic expectation – and an eye – on their investments. And if they take a loss, they learn from it and refuse to let it keep them from investing again.

And now the characteristic that’s becoming increasingly critical to investing success…

Smart money ignores official government reports and relies on its own research. There are many examples of government reporting that is patently off base (i.e. a lie). A current example is the Bureau of Labor Statistics Consumer Price Index (CPI) number. That number hovers around an annual core inflation of a mere one percent. Consider your real world experience with rising energy, in particular gasoline, and food prices. When looking at all your expenses over the past year, have they risen just one percent since last summer?

Here’s what real inflation looks like compared to what the U.S. government reports. (Graph courtesy of Shadow Government Statistics).

Real Rate of Inflation

As you can clearly see from the graph, there has been a growing divergence between the government produced CPI numbers and the Shadow Government Statistics (SGS) Alternate CPI – “the real rate of inflation”. For more information on how SGS calculates their CPI measure go here.

Costs in every major area of our lives have risen far more than what the government states in its core figure. The smart money ignores the official report and instead focuses on its own research and data.

With the above description of smart money, the next logical question to ask is, how do I start thinking like smart money?

To answer that question, you first must understand their investing time horizon. They’re not looking at next week or next month like a trader would. Nor are they looking so far out that it would take the rest of their lives to realize a profit. The smart money is looking at the likely trends over the next few years.

I think they’re asking themselves questions like these:

  • Is real inflation likely to rise or fall over the next few years?
  • What are the best sectors to invest in over the next few years – is it commodities, biotechnology or stocks?
  • What’s more likely – that interest rates will remain at historic lows or move higher?
  • Is the U.S. dollar likely to be stronger or weaker in the next few years?
  • What is the best way to hedge against egregious debt and runaway government spending?
  • In general which assets are most likely to make money over the next few years? Which should be avoided?
  • Is it time to invest in real estate again, or will it take the rest of my life to see big profits?
  • Will the global economy be on solid footing during the next few years?
  • What’s the best energy investment (is oil, or something else)?
  • Are gold and silver viable investments. Will the bull market in precious metals continue in the coming years?

The answers to these questions will dictate, to a large extent, how the smart money invests in the next few years.

No one, of course, can predict the future. If you refer to the above graph you’ll notice some interesting and possibly recurring trends in the rate of inflation and value of the dollar. During the crisis of 2008 the inflation rate plunged, dipping into deflation briefly according to the government CPI numbers. During the late summer and early fall of 2008 the dollar rallied by 20 percent – a huge currency move in a four month period.

As the Federal Reserve embarked on its monetization policy, they were temporarily successful in re-establishing inflation.

This summer as the crisis has worsened (or re-worsened as the case may be) the dollar has yet to strengthen appreciably and gold continues its move higher. And QEII has successfully increased inflation far beyond what the government will public admit. It is my belief that we are due for another bout of falling inflation – possibly deflation – and a strengthening US dollar.

What does this mean:

  • Stocks will fall, possibly significantly.
  • Commodities will be hammered – including gold and silver.
  • Treasury yields will continue to fall. The bull market in Treasury will continue – at least for the remainder of the year.
  • The dollar will rally, perhaps strongly. The dollar rally presents perhaps the best contrarian investment opportunity of the year. Nearly everyone, and I mean everyone, is sure the dollar is doomed as a currency – it will continue it’s fall into oblivion. I’m not suggesting that ultimately won’t  happen. But, nothing goes straight down. The dollar is due for a rally. It may be short lived, but I believe it will be sharp.

Is History Repeating Itself?

In the 15th century, China was home to the highest standard of living in the world. This was China during the Ming Dynasty. Places like Sichuan had reached the pinnacle of civilization at the time with modern infrastructure, robust economies, international trade and a prosperous middle class.

On the other side of the globe, Europeans were living short lives mired in squalor and poverty. They were dying by the thousands from the bubonic plague. They were practically Neanderthals compared to the Chinese. Explorers like Marco Polo wrote fanciful tales of the wealth and opulence in the east.

If you had told a Chinese merchant at the time that, over the course of the next several hundred years, global ascendency would shift to Europe (and a relatively unknown American continent), you would have been laughed at. It was unthinkable given how advanced China was over the west.

But, it happened. The Industrial Revolution and technological achievement caused the table to turn and economic, social and political power to shift from east to west. It has remained that way for several hundred years.

The table is turning once again, back to the east, and it is driven by several factors.

At the tail end of World War II, a new global financial system was concocted that was biased to benefit the United States. In may respects the United States was the “last man standing” after World War II. Europe was in shambles, Russia and China were mired in Communism and the rest of the emerging world wasn’t of any consequence yet. Since that time, foreign countries have been mopping up U.S. government largess and financing out of control  U.S. consumption.

In some respects people the world over (but especially here) felt it was a natural right of Americans to have big homes, cheap gas, and lots of trinkets. Governments at all levels bought into the idea as well. Why couldn’t government buy anything it wanted or make outrageous promises to its constituents without giving a second thought to how these obligations would be paid for. Unfortunately, much of this largesse was made possible at the expense of peasant workers overseas.

For years other countries have imported US inflation while suffering a significant disparity in standard of living compared to the U.S., all because of how the global financial system was constructed. This system, based on the United States as the center of the economic universe, is broken. It will be the biggest game changer in centuries.

There is no shortage of news and opinion about the viability of our way of life, both pro and con. Is it possible that such a force can be stopped or reversed? Highly unlikely.

These huge changes in the global order happen slowly, like gigantic ships changing course. The seeds of change were planted decades ago when the US began running consistent budget deficits in the early 1960s and even before that when the Federal Reserve Act was passed in 1913. The event which may go down in history as the final straw occurred in 1971 when then President Richard Nixon removed all ties between the dollar and gold.

The negative momentum has been building for an long time. Today’s debt, inflation, dollar debasement and unemployment crises are merely the latest symptoms of a cancer that has been growing for seven decades.

The patient is likely beyond cure at this point.

The US debt situation is already precarious. Even the government’s own budget shows continued deficits for years and years to come. This represents some level of risk for the nation’s creditors, and market participants are likely to require a greater return on investment in order to justify the risk of loaning money to the US government. That translates into higher interest rates and higher government borrowing costs, something the federal government can ill afford.

Even assuming that all existing debt is rolled into new bonds, higher borrowing costs will cripple the Treasury. The more money they borrow, the higher their borrowing costs will become; yet, the higher their borrowing costs become, the more money they’ll have to borrow to make interest payments. It’s a vicious circle.

If you’re at all familiar with the financial condition of the federal government, you’ll see that mandatory entitlement programs like Social Security and Medicare soak up more than 75% of all federal tax revenue collected. That’s before paying a penny in interest on the debt. The rest of the budget constitutes several trillion dollars in other, “non-mandatory” expenses.

When you add in sacrosanct budget areas like the military, tax revenue falls over $400 billion short of expenses. America has to borrow to pay its interest expense.

Is it possible for a white knight to come riding in and slash spending by the necessary (and brutal) 50+ percent just to break even? Possible, but extremely unlikely without granting him/her dictatorial powers. Getting a majority of 435 members of Congress to sign up for such painful political consequences is dubious at best. We just don’t have the political will to voluntarily face the music.

Even still, such draconian cuts would just be enough to break even. In order to actually make progress on paying down the debt, one would have to make even steeper cuts… and that’s at today’s levels. The debt grows worse by the day.

Borrowing costs will inexorably rise, causing the budget deficit to spiral out of control.

Since so much of the global financial system is based on the U.S. treasury market, this will set off a chain reaction of bank defaults and commercial bankruptcies, not to mention trigger a wave of credit default swap and other derivative obligations to the tune of several trillion dollars.

Another (more likely) possibility is that the Federal Reserve will continue to finance the deficit by conjuring additional money supply out of thin air, eventually leading to a loss of confidence in the dollar as a reasonable store of value.

The only reason this hasn’t happened already is because there is no viable alternative to the U.S. Dollar as reserve currency… yet. However there are signs that investors and foreign governments are scrambling for a solution. Alternatives like the Swiss franc, Singapore dollar, and gold are all at record highs.

Barring a benevolent dictator or some kind of miracle, this situation is irreversible until the next cycle of the global pecking order turns the tables once again.

The Dollar Is Doomed, Right?

Save for a few deflationists relegated to the hinterlands, the majority of financial bloggers and advisors are firmly on “the dollar is doomed” bandwagon. Can all these expert opinions be right when they’re all on the same side of the same trade? Apparently the answer is “yes”.

When there exists an absolute consensus about anything, even something as “obvious” as the demise of the dollar, my contrarian sense begins to tingle.

Since the Federal Reserve began “quantitative easing” three years ago the direction of markets – all markets – has been clear to all. Yet, why doesn’t anyone sense a disturbance in The Force when all asset classes rise in lockstep together? It is all one trade – the anti U.S. dollar trade.

No wonder. Following is a long-term chart of the dollar. It is ugly, and yes, it looks to be on a downward path.


But nothing goes straight down, even when the Federal Reserve is doing it best to debase the dollar. Even with the turbulence in the stock market of the past six weeks it appears that there are no bears left in any trade except for dollar bears. Bears have been eradicated elsewhere. There has been one guaranteed-to-win strategy: buy the dips.

Ultimately, it is likely that the dollar is doomed. All fiat currencies eventually go to zero. They are designed to. Yes, all currencies are in a race to the bottom. Yes, the dollar has already lost 96 percent of its purchasing power since 1913 (the year the Federal Reserve was formed). Yes, all we’re really talking about now is the last 4 percent–but still, it is striking that bearish sentiment for the dollar is so pervasive.

All of the big-name financial pundits and gurus appear to be in lockstep, so much so they might as well be wearing band uniforms and marching down Wall Street in formation.

The future is never this easy to predict. When has it been this consistently easy to mint profits? I’ll tell you when – during the final stages of a bubble. Only then can everyone win by piling in on the same side of the trade. Just bet against the dollar and bet on permanent inflation in tangibles and equities. It doesn’t matter, everything is going “up, up and away” as the dollar inevitably plummets toward zero.

This reminds me the dot-com (or more appropriately, the dot-bomb) collapse. All the pundits and brokerage houses recommended what, we now know, were worthless dot-coms at $40 per share, down from $80 but still “buys”. It was a “can’t lose” scenario. “Buy the dips.” There was only one small problem: everybody was on the same side of the boat. We know what happens when everyone moves to the same side of the boat – it capsizes.

This uniformity of conviction, this belief in an absolute (“real estate never goes down,” “the dollar is doomed,” etc.) marks the peak of investing bubbles and manias.

Maybe everyone can pile into the same side of the same trade and keep logging gains. If so, then we can all become millionaires with ease.

Maybe the dollar’s value will track everyone’s expectation. Maybe there will be no unexpected bumps in the road. Maybe the inevitable is now visible to all.

Maybe everybody can be right at the same time.

I find it peculiar that when people talk about the dollar’s inevitable demise and the inevitability of hyper-inflation, they speak of the dollar not as a political construct governed by political decisions, but as a Force of Nature, somewhat akin to a boulder rolling downhill. To question the dollar’s demise is like expecting a giant thundering boulder to suddenly stop in mid-air as it tumbles down a mountainside: impossible.

Maybe making money in the markets is this easy and predictable.

Maybe the certainty that the future is clear is this easily predicted.

It seems to have been forgotten, but that’s when things crash. When bears have been eradicated, then the trade has become so lopsided that when it rolls over, it does so suddenly. When everyone agrees, then things become highly unstable. It’s ironic, on the surface, when everyone shares the same convictions, things look rock solid. Yet that very unanimity guarantees instability.

Is America Following in the Footsteps of the Roman Empire?

Many believe there were two primary reasons for the fall of the Roman Empire.  After centuries of prosperity and dominance, the Roman Empire fell like a house of cards.  How could an empire so large and seemingly indestructible crumble so quickly?

The first reason many believe Rome collapsed is due to a decline in morality.  Today this  is known as our “culture war”.  In Rome, immoral and  promiscuous sexual behavior became acceptable.  Homosexuality was embraced. Gambling and alcoholism were encouraged. In short, the Roman Empire fell as a direct result of the immorality among its citizens. This immoral mindset polluted virtually every aspect of their society.

Today in America:

    • We are redefining marriage.  This strikes at our most valuable institution – the family unit!  You destroy families, you destroy society.
    • We allow our judicial system to re-interpret laws to fulfill the agenda and mindset of the far-left radical progressives (aka the “living constitution”).
    • We allow the liberal media to influence citizens into accepting immorality as normal behavior.
    • We allow society to influence our churches instead of our churches influencing our society.  Many churches are watering down their “message” to be more accepting and acceptable.

The second reason many believe Rome fell was because it over extended itself financially and militarily.   Rome built a large army and spread itself “too thin” over a vast empire. It racked up enormous debts and tried to debase its currency as a way out of debt.  This failed miserably.  Why should it work this time around for the United States?

The parallels are astounding and troubling.

Here is how a currency, and consequently an empire, collapses:

Stage 1: Currency starts out solid – backed by a precious metal (gold and/or silver)…

Stage 2: As the country develops economically, it takes on more economic burden – layer upon layer of public works and social programs…

Stage 3: As the country’s political influence grows, so does military spending…

Collapse of the DollarStage 4: With all that military spending, now the country’s military is put to use and expenses go through the roof…

Stage 5: To pay for war and other crippling expenses, the country prints more money…

Stage 6: As the country prints more and more money, severe price inflation takes place and faith is lost in that country’s currency…

Stage 7: The country’s currency then collapses and money flows back into precious metals such as gold and silver…

Today, the U.S. Dollar is between stages 5 and 6.  Those who realize this and prepare for what is coming by properly positioning their assets can make a fortune.  While those who remain uniformed could lose it all.