Jan 11, 2009
Prosperity Dispatch: Reader's Q&A
Andrew Mickey, Q1 Publishing
We’ve delved into all kinds of different subjects in the Prosperity Dispatch. We have turned over a lot of stones to find the opportunities and avoid the real disasters.
It hasn’t all been a one-sided conversation though. Many of you have sent in responses to articles, including questions, comments and critiques. If you’re wondering why you haven’t received a detailed response, let me explain.
Technically, I am precluded from giving away personalized financial advice for many reasons. But I can address each response that I receive. So, I will be publishing Q&A sessions like this every now and then. So feel free to drop us a note with a question or comment. You can send it to amickey@q1publishing.com or simply “reply” to this message and we’ll get back to you.
I’d like to remind you, I still believe if you can make the right moves in the next few years, a truly enormous fortune and true financial freedom will be easily within reach. It’s an exciting time to be an investor and now is not the time to throw in the towel.
So I appreciate the feedback because it lets me know you haven’t given up yet. Over the next few years, a lot of investors will give up. But that’s the time to be buying.
With that in mind, let’s have a look at the questions and (hopefully, helpful) answers.
Q: I recently read your article about investments which are better than savings bonds (The Best 3 Ways to Give the Gift of Prosperity) in which you talk about areas of opportunity in this current market such as stem cells and buying farmland.
You mention a couple of stem cell research companies like Geron, but my main question is how does an investor go about buying farmland? Where would be a good spot, and outside of actually buying actual acreage? – P.M.
A: Farmland can be a tricky one, but it’s well worth the effort when you find a suitable way to invest in it. It’s one of the safest investments you can make over the long term.
There’s just so much to love about farmland. The “Peak Soil” issue, biofuels, rising population, etc. Frankly, everyone knows about those now. What most don’t realize is just how truly safe farmland is. I’ve always considered better than gold. Here’s why.
According to the National Council of Real Estate Fiduciaries, farmland has increased by 11.02% per year between 1992 and 2007. If you look at it before the ag boom really got rolling in 2004, farmland climbed in value by 7.47% per year on average.
That’s one of the comforting characteristics of farmland – prices are not very volatile. In fact farmland only had one down quarter in the last 15 years. The decline was in Q4 2001 and accounted for a loss of 0.001%. Not bad for a time when September 11 started off the quarter, the stock market declined, economy was in a recession.
On top of all that, farmland offers great protection from hyperinflation. During the Weimar Republic years in what is now Germany, hyperinflation destroyed the economy. The farmers fared relatively well because they sold their crops at prevailing prices and were protected from hyperinflation.
But I digress (Sorry about that…I tend to get excited about farmland) You ask, “Where would be a good spot, outside of actual acreage?”
There are quite a few options here. One of the most popular is Cresud (NASDAQ:CRESY). It’s one of the most actively traded farmland stocks in the world. It got a lot of attention when the ag boom was raging a few months ago. Most investors missed a key issue with Cresud.
Long-time Prosperity Dispatch readers may recall a recent research trip to Argentina. We learned a lot from this trip. One of the key things is that Cresud primarily manages marginal farmland.
Basically, Cresud is built for booms. When ag prices are high, Cresud’s farmland is very profitable (valuable). When ag prices are low, Cresud is barely profitable (much less valuable). When it comes to agriculture, the boom time has passed for a while.
Although we expect ag commodity prices to recover this year as on inflation fears, there will be a strong tendency towards deflation at some point over the next five years. This period will likely push Cresud shares down to $4 or $5 or lower. That would be the time to start buying this popular farmland company.
For the long-term, I recommend looking towards Eastern Europe. One of my favorite farming stocks has long been Landkom (LKI:LSE).
Two years ago I was in the Ukraine looking at farmland. I’ve never seen anything like it. It was like going back in time. A few of the Ukrainian farms were still using oxen.
That’s when I realized a key difference between Ukrainian farmland and North American farmland. Ukrainian soil hasn’t been destroyed by 50 years of over-farming. It hasn’t been raped yet. That will be very important in the years ahead.
Also, Ukraine still has rich soil and a huge chunk of its ag production is exported to India. It’s a double dose of growth.
Of course, there are other considerations. You have to look at whether the farm company leases or owns the farmland, political landscape (Ukraine is a risky spot to be right now), soil quality, and a few others. But if you’ve got a 15 to 20 year time horizon, it would be tough to go wrong with any farmland stock.
Q: Can you give suggestions (stocks, funds, ETFs) about investing in farmland and India. As for India, do you think Wisdom Tree India Earnings (NYSE:EPI) is a good choice? – K.G.
A: Farmland is going to be one of the big opportunities and I’m excited to tell you I’m currently researching a few unique opportunities in farmland. I’ve found a few private partnerships (which pay some pretty hefty dividends!) and alternative ways to get in on the impending “Peak Soil” crisis. We’ll delve back into them in the coming weeks and months ahead.
As for India, the options are quite limited for North American investors because there are rules against foreigners investing directly in Indian stocks. There are exceptions to the rule for institutional investors though.
That’s why I recommend sticking with those institutions and simply buying ETF’s. Over the next 15 to 20 years, India has a lot of growth ahead of it. Frankly, it’s far more important to “be there” rather than worry about picking individual stocks.
Think of it like you’re planning a vacation. What’s more important, where to go or on what hotel to stay at? It’s tough to find a horrible spot in Hawaii to escape the cold. Look at investing in India the same way.
Also, picking one or two stocks and holding for 15 to 20 years can be risky. Just look at the Satyam (NYSE:SAY) scandal earlier this week. Had you selected this as one of your top ways to ride the India wave, you’d have lost big.
Those are the two reasons why I’d recommend diversity. ETF’s like the one you mentioned, Wisdom Tree India Earnings (NYSE:EPI), and Powershares India (NYSE:PIN) are two diversified ways to get in on India. There are also a few mutual funds out there, but annual fees of 2% or more just aren’t worth it for many of the international funds.
On top of everything else, Indian rupees are just off its lows for the decade. Rupees have only been this cheap twice in the past decade, the summer of 2002 and now. A cheap rupee makes Indian shares even cheaper in U.S. dollar terms and allows you to buy about 20% more for the same amount of U.S. dollars.
Q: Hello, I have read your article on buying bonds and I agree with you.
I have never traded bonds before I do not know how to go about it. I have a self-directed retirement savings plan in which I can buy and sell stocks and bonds. Where do I go to look for the company bonds you mention?
There must be a list, like the stock exchange out there no? Any help that you could give me to get started in buying and selling bonds would be appreciated. – K.C.
A: Bonds have started to attract a lot of attention. Top investors are starting to buy up high-grade corporate bonds.
For instance, David Swenson, manager of the perennial top-performing Yale Endowment Fund, recently said, “There are some really extraordinary opportunities in the credit world. Everything, from bank loans to investment-grade bonds to less-than-investment grade bonds, is priced at really extraordinarily cheap levels.”
A recent Bloomberg headline proclaims, “Asia Money Managers Warm to Company Debt as Yield’s Shout ‘Buy’”.
But the key thing is how to play it and how to avoid the pitfalls. When it comes to bonds, there are two key things to keep in mind: quality and liquidity.
Considering we’ve got a long road ahead of us economically, I’d stick to the highest quality bonds. Those rated AA or higher. The highest ratings go to companies which generate tons of free cash, have strong balance sheets, and don’t really need to borrow much to stay in business.
The other concern is liquidity. Bonds are notoriously illiquid. They’re tough to sell. When you do want to sell them, you’ll usually lose 2% or 3% because of the lack of bids. If we go through another liquidity crunch and you decide to sell, you could easily lose 10% to 20% just to sell them.
As a result, I recommend using more stringent asset allocation principles than normal. Individual investors should not put more than 1% of their portfolio into the bonds of any one company or a liquid ETF or mutual fund.
1% to 2% in management fees compared to diversified exposure to bonds as opposed to having to lose 10% to 20% because you want to sell into an illiquid market. It’s a cost/benefit situation. To me an extra cost of 2% per year to avoid a potential disaster is certainly worth the price.
There are plenty of good bond funds out there. PIMCO Investment Grade Corporate Bond Fund (PBDAX) has an average credit quality is AA-. It focuses on high quality bonds. Also, it is backed by PIMCO. PIMCO is the largest bond manager in the world which and it is headed by the best of the best when it comes to bonds - Bill Gross and Mohammed El-Erian.
Q: Thank you for your articles. Very helpful. Where can I find bonds from Wal-Mart or DuPont yielding 9 or 10 percent? I looked on Ameritrade and they were yielding in the 4 to 6 percent range (if I was calculating correctly).
Your article, “Corporate Bonds Haven't Been This Cheap Since 1932”, indicated that bonds issued companies such as Wal-Mart or DuPont are yielding 9 or 10 percent. – M.W.
A: There’s no way around this one. This is actually a mistake on my part. Not a research mistake, but an error in communication.
In the article, I stated, “Stocks are cheap, but bonds are at irresistibly cheap levels. If you’re looking to buy low, sell high and collect 9% or 10% interest in between, corporate bonds are definitely worth a look right now.”
I was referring to all investment grade bonds. That means BBB or better. I used Wal-Mart (NYSE:WMT) and DuPont (NYSE:DD) as corporations which offer investment-grade bonds. Bonds from these companies are AAA rated. As a result, they will only pay between 4% and 6% depending on maturity dates.
Corporate bonds still offer some of the best return for the risks involved. To get the 8% to 10% yields, you have to move up the risk ladder a bit and you’ve got to be choosy at those levels.
Still though, high-grade corporate bonds are one of the best places to have your “safe” money right now. After all, would you rather lend money to the U.S government for 2% or Wal-Mart for 4%?
Q: I’ve read the Property Dispatch for the last 3 months or so and I find it informative. However, I fail to appreciate this idea of "short GLD, long GDX" trade. Looking at the past few months it seems both go up or down together, while to make money in this trade we need GLD to go down while GDX goes up - why do you think that would happen? – K.G.
A: The one thing I’m always on the lookout for is non-directional, or “market neutral,” trades. These are the types of situations which allow you to profit whichever way the market goes.
To be honest with you, I still think gold has a lot more room to run before it comes crashing back down when deflation truly sets in. But there are ways to profit from a run in gold without having to bet the farm…so to speak.
Let’s go back about 10 months ago when gold was near $1,000 an ounce. SPDR Gold Shares (NYSE:GLD) were sitting at about $100 a piece. The Market Vectors Gold Miners ETF (NYSE:GDX) was sitting at $56 per share at the time. The GLD/GDX ratio was at 1.78 – 100 shares of GLD would buy 178 shares of GDX.
Right now, GLD is at $84 and GDX is at $32. The GLD/GDX ratio is at 2.62. So you can sell short 100 shares of GLD and buy 262 shares of GDX.
Let’s say gold prices could easily return to $1,000 in 2009. The GLD would be back around $100 right? And there’s no reason not to expect the GDX to go back to $50 to $56 range. If that happens, you’ll lose 19% on the GLD short (19/84), but you’ll be up 75% (56/32).
By shorting GLD and longing GDX, you’re basically sacrificing a little upside potential for a lot of downside protection. This is a bet on the return to historical norms and nothing else. If gold goes up and gold stocks soar, we’ll win. If gold goes down and gold stocks go down less, we’ll win.
The big part of this is how much capital you have tied up. For instance, if you sell short $10,000 worth of GLD, you collect $10,000 cash right away. You can take this and roll it over into GDX shares. That way you have to keep some cash on hand to meet the margin requirement, but only enough to meet margin requirements for a “market neutral” which most brokers will keep to a minimum for you because you’re hedged out in multiple directions.
There is one risk with this trade though (there’s no reward without risk). John Maynard Keynes said, “Markets can stay irrational for longer than you can stay solvent.”
Right now, the Gold/XAU ratio (which we use GLD/GDX in place of – not perfect, but close) is way out of whack compared to its 25 year average. And, although highly unlikely, it could get more out of whack. However, it’s working back to normalcy. I bet this is going to take some time, but should be worth it in the end.
Q: Thank you for your thoughtful note on the “Trade of the Year”. However, just to show that there are many different ways to look at numbers I come to a completely different conclusion from the same data.
I think gold is just about where it should be, the Dow is too expensive and oil is too cheap. Therefore, my trade of the year is to sell the Dow and buy oil.
We know, based on production and storage costs that oil can’t go down too much below $35 and it is not reasonable in my view to see the Dow going up too much more than 10,500 in less than two or three years.
I suggest the risk reward balance is more in my favor than your trade. Also, you do not have to do any shorting and you can use IRA assets to do the trade employing ETFs only. – F.Y.
A: There are a lot of ratios to look at out there and they all tell you take different action. We looked at three of them and what they were telling us to do. In the Trade of the Year article we looked at all of them and picked the most extreme situation.
You bring up the Dow/oil ratio. If you look at the chart below, you can see
how this ratio has moved over the past 23 years.
From a big picture perspective, if the economy recovers strongly and justifies a Dow 11,000 or 12,000, oil prices are certainly going to be significantly higher. So you might lose 30% on the Dow short and gain 80% or 100% on oil.
I don’t foresee the Dow or the economy recovering that strongly or quickly (I don’t the market fully understands what 9% or 10% unemployment will do to corporate earnings yet), but you’re thinking the right way for how to make some good money in a flat market.
I’m a big believer in investing at the extremes. The Dow/Gold ratio has been significantly lower and significantly higher – it’s not at the extreme low end or the high end.
The Gold/XAU ratio is truly at an extreme. When my research found the ratio of ratio of gold to gold stocks was at its highest point in more than two decades, double the long run average, and working its way back to historical norms, I say that’s a bet I’m willing to take.
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I hope all that helped clear some things up.
The investment world is a crazy place right now and opportunity and disaster lurk can be found on the other side of many doors. I’m glad you’re with us as we explore what’s behind each one.
The next few years are going to offer some tremendous opportunities. There’s a treasure waiting on the other side of the minefield, but we’ve got to make it through the rough spots first.
Andrew Mickey,
Chief Investment Strategist, Q1 Publishing
