While I share the great concern about her destructive economic policies of this administration, I am getting a contrarian tick about the dollar and gold.

Every right wing talk show and business TV show is flooded with adds selling gold to consumers.  “The dollar decline is inevitable” the pitchmen warn, “Gold is the only safe money.”

When there is this much noise and whenever anything is inevitable it is time to be cautious.

I remember during the seventies when inflation seemed inevitable. The doomsday newsletters like Harry Brown and Howard Ruff had middle class investors buying gold coins, opening us accounts in Swiss banks and investing in Swiss Franc CDs.  Gold reached over 800 dollars an ounce.

And then the inevitable did not happen.

Volcker and Reagan wrestled inflation out of the system, the dollar soared and gold plummeted. Silver which ran as high as $50 an ounce came crashing down to under $5. The real reason for its rise and spectacular bubble was not the desire for sound money but the manipulations of the notorious Hunt brothers.

Middle class investors who bought into the fear and invested heavily in foreign currencies and gold were badly damaged.

It is challenging enough to get accurate information about domestic stocks. Understanding the factors affecting currency values and foreign markets are far beyond the scope of middle class investors (and most professional investors as well.)

Interest rates are near zero. They cannot go down any further, and given the deficit will likely go up.  When interest rates go up the costs of holding a non interest bearing asset like gold goes up, and this puts down ward pressure on the price of the metal.

While the dollar may seem vulnerable its value on world markets are relative to other currencies. As we see the Dubai fantasy teetering on the brink of bankruptcy and countries like Greece nearing default, the dollar may start looking better if for no other reason than other countries are looking worse.

The amount of uncertainty multiplies greatly when you leave our borders. If you are concerned and want some gold limit your exposure to 10% of  your assets and even dollar average that to avoid buying at a top. Consider gold stocks like Newmont or Goldcorp that you can sell easily and quickly if the market turns against you.

Do not put gold in your 401k or retirement account. The tax protection is better suited to income investments, even low yielding but secure Treasuries. If you think interest rates are going up (I do) avoid long term bonds of any nature. Bond face values drop as interest rate rise.

Successful investing requires controlling your emotions.  Anger and fear over this administration’s policies can easily influence your investment decisions.  Rarely does such emotional influence lead to better decisions.

Is this a good time to buy?

Yes and no. The contrarians are salivating but one can not discount the real risk in this market. Obama’s policies are so radically different on so many different levels that there is a chance that the game may be changed for a decade.

It would be foolish to expect a rapid resurgence in prices. It will likely be a long slow slug from current levels. One should not be testing bottoms here without a lot of patience.

But it would be a good time to begin to buy the strongest players in the weakest industries; especially steel, cars, and banks. A more conservative play would be to starting frequent buying of low cost index funds, especially if the market continues to fall.

Here is my gut risk assessment of this market. There is a 50% chance that we are less than a 1000 points away from a bottom. While 1000 points seems like a wide margin it is small considering the 6,000 drop in the last 9 months. Even if we do bottom above a 6,000 Dow the time frame could be long. This is no time for impatient investors.

I see a 20% chance that the market could drop far beyond 6,000 to say 4,000 and a 10% chance it can go beyond that. I see a 10% chance that we could rebound significantly and rapidly from near current levels. I see this last probability largely because of the massive monetary infusion. The market may benefit from inflation.

Cash and patience are king, but opportunities are available that we may not see again in our lifetimes.

Conversation is fluid between those who believe this is the best time to buy stocks and those who believe that it is the worst time.

Pure contrarian thinking gets more excited about the possibilities the more negative the news gets. They pray for blood in the streets. The best ally of the contrarians is the media who tend to more negative than reality, driving panic and excessive selling. True contrarians must ignore the media. It takes deliberate focus.

On the good side is that there is enormous liquidity in the market. While the loose monetary policy under Greenspan is largely to blame for the financial panic, the fed is responding to this crisis with even greater liquidity. This money must eventually go somewhere. Fear is keeping it in low yield and low risk invenstment.

While unemployment is rapidly growing it is still low comparative to other recessions, and a fraction of the numbers during the Great Depression.

For the time being inflation is low, fuel prices are down as well as other industrial commodities, housing is far more affordable, and wage increases will be restrained by the poor business climate.

Historically stock prices are low, but that does not mean that they can not go lower. A very bright close friend in the real estate business noted that the market can remain irrational much longer than most people can remain liquid.

This does not mean that business will get better quickly or that Obama has the right answer. Raising taxes, reducing deductions, appointing federal czars to ‘oversee’ private industries, bailing out dying businesses, promoting unionization, subsidizing bad behavior, trying to support housing prices that were inflated by poor fed policy, massively increasing spending on health care, education, and every other ‘worthy’ cause, increasing welfare spending, lengthening unemployment benefits, massive infrastructure outlays during a time of declining earnings and tax generating income seems antithetical to every lesson we have learned in the last 100 years about fiscal discipline.

Obama has clearly fulfilled his campaign promise of change but he has avoided the far more difficult problem of choice. He intends to have it all. The street understands the tremendous risk of his policies.

The contrarian choice believes that we will return to a historical trend. The market extremities that flew above the mean have dropped well below the mean and will eventually return to the mean.

But if Obama’s radical reversal of numerous policies at one time signals a reversal of a long term trend then the contrarians may be wrong. Investors constantly read the disclaimer that past results are not indicative of future expectations, but they may be having trouble truly believing it at a time when they should be giving it very special consideration.

While some stocks are selling at valuations lower than we have ever seen, that doesn’t mean this market is without real risk. With such dramatic changes the game may be changed for years to come.

But certainty in the market carries a very high premium. The two best assets now are patience and cash. It will likely be a slow slugfest to return to market highs. But it would be a good time to start buying the strongest players in the weakest industries. The market may have long discounted the worst that can happen in those industries. A reasonable speculation would be to start slowly placing money in a low cost index fund.

It seems simple to acknowledge the wisdom of buying low and selling high, but this market clarifies why some wisdom that seems easy to understand can be so difficult to execute.

It is amazing what intelligent people are willing to believe when paid enough money.

So many of the rich and the elite willingly invested with Madoff in spite of suspiciously good returns. “I don’t know how he does it, he just does,” was a common response to those who questioned his method. Certainly his stature as an ex Nasdaq chairman gave him a credibility, but should that have entitled him to a secret no one else in the investment world possessed?

To even a modest analyst or regulator his claim of an options strategy should have alerted their skepticism; there weren’t enough options in the market to fund such a strategy for the amount of money he had invested. But the sheer size of his fund gave him legitimacy. Many of the rich elites he managed felt entitled to the superior returns that are unavailable to the little guy left with mutual funds with high fees.

Yet the little guy expecting his house to appreciate year after year was just as foolish. ‘Get rich quick’ hucksters and the real estate industry knew that pure demographics would be putting pressure on housing. Retiring baby boomers would be downsizing and moving into smaller homes, with fewer younger parents to buy the old larger homes.

Markets regress to the mean. Housing, gasoline prices, China, scrap, tech stocks- nothing goes up for ever. Nor have I ever seen a market rise exponentially and then just level off.

I do not think it is just a coincidence that the bursting of the housing bubble and the outing of Madoff happened simultaneously. Government sponsored Fannie Mae and Madoff are one and the same; they pushed impossible returns using plain deceit that everyone was willing to believe as long as they profited from it.

But while Bernard Madoff will be drawn and quartered in the public square (justifiably in my opinion), no one from Fannie Mae will serve a day in jail.

John Bogle writes in the Wall Street Journal Online-

Beware of market forecasts, even by experts. As 2008 began, strategists from Wall Street’s 12 major firms forecast the end-of-the-year closing level and earnings of the Standard and Poor’s 500 Stock Index. On average, the forecast was for a year-end price of 1,640 and earnings of $97. There was remarkably little disparity of opinion among these sages.
Reality: the S&P closed the year at 903, with reported earnings estimated at $50.
Strategists aren’t always wrong. But they have been consistent, betting year after year that the market will rise, usually by about 10%. Thus, they got it about right in 2004, 2006 and 2007, but also totally missed the market declines in 2000, 2001 and 2002, and vastly underestimated the resurgence in 2003.

Ignore the forecasts of inevitably bullish strategists. Bearish strategists on Wall Street’s payroll don’t survive for long.

from Ben Stein in the New York Times 12/26/08

They Told Me That Madoff Never Lost Money

excerpt- see entire column here

We are more than our investments. We are more than the year-to-year or day-by-day changes in our net worth. We are what we do for charity. We are how we treat our family and friends. We are how we treat our dogs and cats. We are what we do for our community and our nation. If you had $100 million or $100,000 a year ago and now you have a lot less, you are still the same person.

Losing and making money are not moral issues so long as you are being honest. You may have a lot less money as this year ends than you did two years ago. But you are just as good or bad a person as you were then. It is a myth that money determines who you are, and if you have gotten over that myth by now, then 2008 will have been a very good year.

We are entering the New Year with a lot of pessimism about the stock market and the economy. While I have strong concerns I am optimistic for several reasons.

We have already had a strong move down with a nearly 40% drop in most indexes.

The conventional wisdom is that the worst is ahead. In such strong moves the conventional wisdom is often wrong. At times like this it pays to be a contrarian.

Unlike the Great Depression the Government is not taking a hands off approach. In fact they are bailing out everything in sight. While this may have serious inflationary consequences later I think it may not for several reasons. There are strong deflationary forces in lower fuel and commodity prices, an economic slump, rising unemployment, and the prospect of imports looking for a market in America. While our market is being battered, the rest of the world is having an even worse response.

There are also strong deflationary forces in the budget cuts in state governments who do not have inflation as a tool. Paul Krugman wrote an article called 50 Hoovers, lamenting the deflationary impact of state government budget cuts when the government should be spending to stimulate the economy. The state budget cuts may be counteracting the stimulus of much of the federal spending.

While the news is negative my eyes are telling me a different story. Malls are still crowded even though business is down. A friend travelling noted that all of the flights to Hawaii on a particularly day were overbooked. Restaurants are still crowded.

I will acknowledge that business is down. Car dealers, home builders and banking are getting hit exceptionally hard, but while homes were overpriced they are approaching a normal level where sales will eventually pick up. They may go further but they are closer to a bottom than a top.

Finally there is a ton of cash out there, and the fed is inflating strongly. This money has to go somewhere. When the fear abides and the cash enters the economy’s bloodstream we will see a bounce. Expect a higher Dow this year.

Will a one party government have the discipline to reign in the inflation when the recovery ensues? Will they be able to make the decisions to cut spending and make tough choices? That remains to be seen.

I have searched for a good Value manager, but many who claim to be are not. I have found a manager who is, but his minimums are high, a million dollars. Contact me if your are interested in reaching him.

The Fairholme Fund is a great alternative for those who can swing the minimum $2500. Since 12/29/1999 the fund is up 240% while the S&P 500 is up less than 1%. during the bad sell off in 2002 when the market was down 20% Fairholme was down less than 2%. Their true value technique is simple: “be fearful when others are greedy and be greedy when others are fearful.”

Not surprisingly, some of their holdings match the private money manager.

The annual report of Berkshire Hathaway, Inc. offers some of the best business reading available. It is as plain and unadorned as any other report of such a large company. The content is everything.

Berkshire has averaged 21.1% annual gains from 1965-2007 compared to a 10.3% gain for the S&P 500 with dividends included. Even Warren Buffet acknowledges that such a return in the future is practically impossible given the size of the business. Berkshire consists of 76 operating companies, and is one of the largest employers in the state of Georgia.

Warren points out in the report that the stock market in the 20th Century grew from a Dow of 66 to 11,497. That huge gain represents 5.3% if compounded annually. To continue that same gain for our current century the Dow will have to rise to 2,000,000. So far we are less than 2,000 points toward that goal.

If you forecast a 10% growth (2% in dividends and 8% appreciation in equities) you are forecasting a Dow of 24,000,000 by 2100.

The message is clear- be resonable in your forecast of returns.

Berkshire (BRK.B) closed today at $4,364.50 per share.