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Market Watch: Curb your appetite for high returns

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  • | 5:00 a.m. December 5, 2012
George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.
George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.
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Returns from the stock-and-bond markets aren’t what they used to be. Today, we are mired in an economy going nowhere, which provides limited investment opportunities because of the twin government sins of excess spending and overhanging future tax increases. Forty percent of taxpayers pay 90% of all income taxes, and the top 5% of taxpayers pay 40% of all income taxes. What is the “fair share” to be paid that government asserts the taxpayers are not already paying? Two huge pieces of misinformation cloud our view of what is really happening:

1. Should the government confiscate 100% of the income of the top 5% of taxpayers, there would only be another $350 billion to $400 billion of taxes. The government deficit is $1.3 trillion, annually. Taxing 100% of the income of the wealthiest taxpayers would provide less than one-third of the funds necessary to close the deficit. Further, all of that $350 billion to $400 billion gets reinstated in the economy, and there would be no capital to re-invest in our economy for growth.

2. The fiscal cliff. We are told that if the problems with the “fiscal cliff” are not resolved, spending cuts and tax increases of $675 billion will occur. As mentioned above, deficits of $1.3 trillion will not be resolved with only $675 billion of spending cuts and tax increases, half of what we need to close the gap. How do we invest in an economy with upside-down numbers of this magnitude?

Bonds. The 10-year Treasury bond pays less than 2%, much less than inflation. The government says the CPI is increasing at about 3% annually. Private economists who measure the “everyday” price index say that price increases in our economy are close to 10% annually. Who is right? For purposes of buying bonds, it does not matter who is right. The interest rate on bonds is going to be less than inflation using any price index. Therefore, owning bonds is only going to depreciate one’s purchasing power as long as they hold the bonds, so bonds are not good investments.

Gold and silver. Both are in a 12-year bull market, the largest gold bull market since the 1920s. At the end of the last bull market, the Roosevelt administration confiscated the nation’s gold, which was priced at $20 an ounce, by redeeming it for $20.67 an ounce in 1933. In 1934, the government arbitrarily increased the price of gold to $38.50 an ounce, providing a huge windfall for the government, not for the people from whom the gold was confiscated. When Nixon refused to redeem dollars held by France for gold in 1971, all government spending discipline was severed. A commodity no longer backed our money. Inflation and government debt soared, and gold is now priced at $1,750 an ounce.

With the above background, the current question is whether an investment in commodities such as gold and silver remains a viable option.

Scott Minerd, an analyst with Investment Rarities Inc., states that the ratio of gold to our total money supply is at an all-time low of 17%. He further states gold would sell at $12,000 an ounce. This is incorrect. He is using M1 (dollars in circulation), and he should be using M3, the total money supply*. The U.S. total gold supply is 8,200 tons. The U.S. total money supply (M3) is now a big secret of the Federal Reserve System, but reliable estimates put M3 at $15 trillion. In 1949, every single bit of the M3 money supply could be redeemed at $38.50 an ounce — 100% of our M3 money supply was covered by gold at $38.50. Today, dividing 8,200 tons of gold into the money supply (M3 of $15 trillion divided by 289 million ounces of gold) means that gold would be revalued to $53,000 an ounce to redeem our entire money supply. And that is what paper money will do when politicians are not faced with the discipline of spending restraints.

There are other additional mitigating reasons to purchase gold. Four years ago, governments were net sellers of gold, and now they are net purchasers of gold. China and India have been leading the way, and China holds more foreign currency than any other country. So, if China and other governments are now accumulating gold, that means there will be another huge purchaser in the market, creating demand. In addition to governments now accumulating gold, many funds investing in gold and silver, and big investors such as George Sorros and John Paulson, are in the market. They have hundreds of tonnes of investments in gold. Demand continues to grow. The growing demand for goods and services causes prices to increase unless the supply can be increased commensurately. It cannot. Mining strikes all over the world are inhibiting production increases and causing production in many areas to decrease. 

With the above in mind, it is easy to understand how further investments in gold and silver will be profitable and will act as a hedge toward the government’s continued assault on the dollar through inflation.

Basket of stocks
This is not a market in which one should speculate in stocks. An examination of the least-expensive AAA stocks available right now shows the basket yields 3%, about double the return on bonds. These stocks are companies with the most outstanding performances of increasing earnings and dividends annually, and maintaining that record throughout the last 12 years. They are also selling at an average price earnings ratio that approximates the long-term average price earnings ratio on the Dow Jones Industrials.
Market Watch does not recommend anything. It is our job to provide ideas. The “idea” of the day is as follows: This is not a healthy market in which to speculate. Bonds pay nothing and eat up your principal through inflation. Gold and silver are mathematically our best hedge against pending economic catastrophe.

Finally, if one must invest in the stock market, do so with solid companies that have proven records and huge market shares in their own businesses, which businesses concentrate upon world markets and dominate those markets.

Investors should concentrate upon safety. We may need to curb our appetite for high returns in favor of ensuring our money that’s invested is returned.

Caveat Emptor.

*One of Alan Greenspan’s last acts as Fed chairman was to eliminate M3 statistics, the total money supply. This was more government deception like the CPI. M3 included government debt in the money supply. Government debt is an obligation, like cash, that is owed to whoever holds it, and it is therefore the most significant part of our money supply.


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